Morning Session

1. TV soap star Susan Lucci trades jobs with Buffett

NEWS ANCHOR: (CNBC’s Becky Quick, on tape) Folks, this just in. It appears that Warren Buffett has struck a deal to trade jobs with daytime soap opera diva Susan Lucci. Buffett has reportedly negotiated a permanent spot on the cast of All My Children. Apparently, Ms. Lucci is en route to Omaha as the new CEO of Berkshire. (Applause.)

CHARLIE MUNGER: Where could he be? (Laughter and applause as actress Susan Lucci comes on stage)

SUSAN LUCCI: Do you mean Warren, Charlie? He’s been detained at the TV studio. (Laughter)

CHARLIE MUNGER: Really?

SUSAN LUCCI: Hi, Charlie. I’m Susan Lucci. Oh, haven’t you heard about the deal between Warren and me? He’s going to be a big star in All My Children, and I’m going to be taking over Berkshire Hathaway.

CHARLIE MUNGER: Well, you’ve certainly got some important qualities that Warren lacks. (Laughter)

SUSAN LUCCI: Well, thank you, Charlie. And you can relax now, you dear man. You just make yourself at home because I’ll take it from here, thank you. I’ve been wanting to talk to our shareholders for quite some time now. There’s some changes I really think we need to make around here. The first thing we need to look at is our dividend policy. (Laughter) I have never heard of anything so cheap and so unfair to our wonderful shareholders. We need to change it. (Applause)

CHARLIE MUNGER: Sounds good to me. (Laughter)

SUSAN LUCCI: And, second, we need to look at giving guidance on earnings. And we need to do that every single week. (Laughter)

CHARLIE MUNGER: Sounds good to me. (Laughter)

SUSAN LUCCI: And, third, we need to pay our directors more than $900 a year. (Cheers and applause)

WARREN BUFFETT: Just one minute. (Applause.)

SUSAN LUCCI: Hi, Warren. Warren, I thought you were at the All My Children studio.

WARREN BUFFETT: What’s that talk about dividends that I hear?

SUSAN LUCCI: Oh, nothing important, Warren. You just concentrate on your role on the show.

WARREN BUFFETT: Susan, my show is Berkshire Hathaway. And my role is to run it. (Takes paper out of jacket pocket and rips it up)

SUSAN LUCCI: Warren, you can’t do that.

WARREN BUFFETT: I just did it. All My Children can’t do without you, and I can’t do without Berkshire. (Applause.)

SUSAN LUCCI: Oh, Warren. So you mean the deal is off?

WARREN BUFFETT: The deal is off. I really want to thank you. You’ve brought me to my senses. You can go back to All My Children. I’ll stay here at Berkshire. But I am so grateful to you Susan, that I want you to go out to Berkshire — not to Berkshire — to Borsheims and I want you to pick out anything you would like, and charge it to Charlie. (Laughter)

SUSAN LUCCI: Oh, Warren, you are darling. Thank you. (Applause.) SUSAN LUCCI (to MUNGER): And you’re a darling, too.

WARREN BUFFETT: Now, wait a second.

SUSAN LUCCI: Thank you. (Applause)

2. Welcome

WARREN BUFFETT: OK. Charlie, let’s get this show on the road. (Laughter) The — she spent more time with him than she did with me, but — (Laughter) The — we’re going to follow the usual procedure. The business meeting will start at 3:15. But between now and then, with a break for lunch, we’re going to answer your questions. We don’t screen them ahead of time, as you know — based on who gets lined up at the microphone first. And we’ll go around from sections to sections and then go to the overflow rooms. My understanding is that our best estimate is that we have about 31,000 people here today. (Applause.)

WARREN BUFFETT: Somewhere I have a map here. Marc, do we have that? Pardon me? Can’t hear a thing up here. But in any event — on the yellow pad. OK. We’ll just mark them off as we go along. The — I would like, before we start — I heard Ron Olson laughing there. I think he made it. I’m glad to hear it. Let me introduce our directors. I really wasn’t sure whether to go through with this part of the show after they showed that rousing applause for things like dividends and raising their — but we have up here — we have Charlie Munger on my left. He’s the one that can hear; I can see. We work together for that reason. (Applause.)

WARREN BUFFETT: And if the rest of you will just stand as I give your name. And if you’ll hold your applause to the end — or even longer if you would like — (laughter) — I will introduce them. It’s Howard Buffett, Susan Decker, Bill Gates, David Gottesman, Charlotte Guyman, Don Keough, Tom Murphy, Ron Olson, and Walter Scott. The best directors in America. (Applause.)

WARREN BUFFETT: Charlie and I will take a break at noon because we will probably, by that time, have finished all of the things we have up here to eat, and we’ll need to have lunch. I’d appreciate it if you would limit your questions to one question, and that means not embodying a three-parter or a four-parter or something like that. And there’s no need to make a long introductory statement because we’ll get more questions answered that way, and we want to cover as many people as we can.

3. How NOT to be a lemming

WARREN BUFFETT: So with that, we’ll go right over to post number 1 and start in with the first question.

AUDIENCE MEMBER: Very good morning to Mr. Buffett and Mr. Munger. My name is Rajesh Furor (PH) from Bombay, India. I have been learning a lot from letters of yours. It’s been a great insight into investment philosophy that I haven’t learned from anywhere else. Great job. That’s on the mind side. But on the heart side, what touches me the most is what you have achieved all these years is through a hundred percent honesty, and I salute to that. Thanks.

WARREN BUFFETT: Thank you.

AUDIENCE MEMBER: Now, my question is on what key steps would you recommend to correct the mind set of typical investor like me, which is what you noted as lemmings-like, the crowd mindset?

WARREN BUFFETT: What would we recommend — we got the question being repeated here — about the mindset of an investor? Is that —?

CHARLIE MUNGER: He wants you to advise him as to how he can become less like a lemming. (Laughter)

WARREN BUFFETT: Well, since you repeated the question, I’m going to let you give the first answer to that, Charlie. (Laughter) Until he eats about a thousand calories, it — (Laughter)

CHARLIE MUNGER: He wants to invest less like a lemming.

WARREN BUFFETT: Oh, I understand that. I was giving you the first shot at it. Well, I will tell you what changed my own life on investing. I started investing when I was 11. I first started reading about it — I believe in reading everything in sight. And I first started reading about it when I was probably six or seven years old. But for about eight years I wandered around with technical analysis and doing all kinds of things, and then I read a book called “The Intelligent Investor.” And I did that when I was 19 down at the University of Nebraska. And I would say that if you absorb the lessons of “The Intelligent Investor”, mainly in — I wrote a forward and I recommended particularly Chapters 8 and 20 — that you will not behave like a lemming and you may do very well compared to the lemmings. We have here in the Bookworm, copies of “The Intelligent Investor”, and I think it’s as great a book now as I did when I read it early, I guess, in 1950.

You will never — you can’t get a bad result if you follow the lessons of — Ben Graham taught in that book. I should mention that there’s a book out there also that I did not know it would be completed by this time. My cousin, Bill Buffett, has written a book about our grandfather’s grocery store called “Foods You Will Enjoy.” And Bill will be out there. He’s signing books. I just got my first copy a couple days ago. Read it, and I enjoyed it a lot. Charlie worked at the same grocery store — how many years ago? Probably a good 70 years ago in Charlie’s case. Neither one of us was very good. (Laughter) But my grandfather — you don’t want to pay much attention to his advice on stocks. He wrote a lot of letters, and he was very negative on the stock market and big on hard work at the grocery store. So we quit listening to him. (Laughter) Instead, read The Intelligent Investor. That’s the book that gave me the philosophy that has taken me now for a lot of years.

And there’s three big lessons in there which relate to your attitude towards stocks generally, which is that you think of them as parts of a business; and your attitude toward the market, which is that you use it to serve you and not to instruct you; and then the idea of a margin of safety, of always leaving some extra room and things. But the people in this room, I think, have learned that important first lesson. I mean, I think most people that own Berkshire do not see themselves as owning something with a little ticker symbol or something that may have a favorable or unfavorable earnings surprise or something of the sort, but they’d rather think of themselves as owning a group of those businesses that are out there in the other room. And that’s the way to look at stocks. You’ll never be a lemming if you do that.

4. Buffett will handle Cologne Re’s investment portfolio

WARREN BUFFETT: Let’s go to Number two.

AUDIENCE MEMBER: Good morning, Warren. Good morning, Charlie. My name is George Iscis (PH) from Cologne, Germany. My question: how is the operational integration of the Cologne Re progressing? Thank you very much.

WARREN BUFFETT: Cologne Re, for those of you who are not familiar with it, is a 95 percentowned subsidiary of General Re, of which Berkshire Hathaway owns 100 percent. And Cologne Re, I believe, is the oldest reinsurance company in the world. It’s done a magnificent job for us as part of, first Gen Re, and then Berkshire Hathaway. And we have a process in place that will, before too long, result in us owning a hundred percent of Cologne. One difference, then — there won’t be any difference in operation. It runs magnificently the way it’s being run. But at that point — up until this point, they have run their own investment portfolio. That portfolio and the equity portfolio of GEICO are the only two that I don’t run. But when we own a hundred percent of Cologne, then I will take the responsibility for Cologne’s investment portfolio. Otherwise it would be hard to improve on the operation of the management of Cologne. So there will be — you will not see any other changes except we will consolidate in 100 percent of the earnings of Cologne rather than 95 percent.

5. “Forget about the word ‘stock’”

WARREN BUFFETT: Area 3.

AUDIENCE MEMBER: Good morning, Mr. Buffett, Mr. Munger. My name is Sam Reiner (PH) from Fort Lee, New Jersey, and my question concerns your comment this week about the recession, and the stock market going up so significantly in April. Can you expand on where the market is going from here? (Laughter)

WARREN BUFFETT: Hah. Well, I can expand, but I couldn’t answer. (Laughter) Charlie and I haven’t the faintest idea where the stock market is going to go next week, next month, or next year. We never talk about it. You know, it never comes up. Our directors will tell you that they’ve never been to a directors meeting where the subject of the direction of the stock market is — we are not in that business. We don’t know how to be in that business. Obviously, if we could guess successfully a high percentage of the time where the stock market was going to go, we would do nothing but play the S&P futures market. There wouldn’t be any reason to look at businesses and stocks. So it’s just not our game. We don’t think — what we see when we look at the stock market is we see thousands and thousands and thousands of companies priced every day, and we ignore 99.9 percent of what we see, although we run our eyes over them.

And then every now and then we see something that looks like it’s attractively priced to us, as a business. Forget about the word “stock.” So when we buy a stock, we would be happy with that stock if they told us the market was going to close for a couple years. We look to the business. It’s exactly the same way as if you were going to buy a farm a few miles here outside of Omaha. You would not get a price on it every day, and you wouldn’t ask, you know, whether the yield was a little above expectation this year or down a little bit. You’d look at what the farm was going to produce over time. You’d look at expected yields. You’d look at expected prices, the taxes, the cost of fertilizer, and you would evaluate the intelligence of your purchase based on what the farm produced relative to your purchase price. Quotes would have nothing to do with it. That’s exactly the way we look at stocks. We look at them as businesses. We make judgments about what the future of those businesses will be.

And if we’re right about — in those judgments, the stocks will take care of themselves. Charlie?

CHARLIE MUNGER: Nothing to add. (Laughter)

WARREN BUFFETT: He’s been practicing for weeks. (Laughter)

6. We don’t cultivate great managers, we keep them

WARREN BUFFETT: Let’s go to area 4.

AUDIENCE MEMBER: Good morning, Mr. Buffett and Mr. Munger. My name is Chander Chavla (PH), and I am from Seattle, Washington. Berkshire Hathaway has some of the best managers in the world, and I am very bad at hiring good managers. The — some of the decisions that I’ve made, which were without any phone calls from Jamie Lee Curtis, I look back and I see — you know, what was I thinking. What can you advise on, how in one hour you can assess the capability of a person to be a good manager?

WARREN BUFFETT: Well, you have to understand that we cheat. (Laughs) We buy businesses with good managers. So if you give me a hundred MBAs — and I have these classes come out all the time to Omaha. I’ve had about 30 schools this year, and usually there’s 75 or a hundred men and women in the classes. I no more could take those hundred and spend a few hours and rank them from number one to a hundred in terms of their future achievements as managers, you know, than I could pick them — you know, it would be impossible for me. But what we do is we buy businesses with great managers in place. We’ve seen those people perform for, in many cases, decades. We’ve seen their record, and they come with the business. Now, our job is not so much to select great managers, because we do have this proven record that they come with. Our job is to retain them. And many of the managers — a majority of the managers that work at Berkshire — are independently wealthy. We hand them checks, sometimes, in the billions, often in the hundreds of millions.

So they do not have a monetary reason to work, in many cases. So our job — we are dependent on them, incidentally. I mean, we have 19 or so people at headquarters, and we have 250,000 working for Berkshire around the world, and we can’t run their businesses. And our job is to make sure that they have the same enthusiasm, excitement, passion, for their job after the stock certificate changes hands, than they had before. Now, that requires some judgment on our part as to whether these people love the business or love the money. They all like money, but many of them — well, our managers in particular — they love their businesses. I mean, they’ve worked at them — they’re a work of art to them, and they’ve been in the family sometimes as many as four generations. So we have to see the passion in their eyes, and if we see that, then we have to behave in a way that that passion remains. Can’t be done by contract. We don’t have contracts. It won’t — that doesn’t work.

But we can try to create an environment — and Berkshire, frankly, is the ideal environment — it’s even an ideal environment because of events like this. Our managers feel appreciated. And they are appreciated. They’re not just appreciated by me and Charlie; they’re appreciated by you. And we want to give you a chance to applaud them. (Applause.)

WARREN BUFFETT: So I can’t be of enormous help. And if you’re looking at a group of MBAs, you know, it’s not easy. I mean, they know — they sort of learn by that point in life how to fool you, in terms of what answers you want to hear and all of that sort of thing. I would look for the person with passion for the job. I mean, the person that is always doing more than their share. You look for people that are goods communicators and all of that sort of thing. But I like my way better. It’s a lot easier just to take somebody that’s been batting .400 in baseball and say, “I think I’ll stick them in the lineup.” And the nice thing about our game is that, you know, in baseball, unless you’re Nolan Ryan or somebody, you have to hang up things at 40 or thereabouts, but in our game, they go on and on and on. I mean, I use as an example — we had a famous Mrs.

B from the Furniture Mart, and she worked for us until she was 103, and then she left and she died the next year. And that is a lesson to our managers that — (Laughter) Charlie?

CHARLIE MUNGER: Well, that was very useful advice. It reminds me very much of the late Howard Ahmanson. And a young and starving business student once asked him for advice as to how to get ahead, and Howard said, “Well, I always keep a few million dollars laying around in case a good opportunity suddenly turns up.” (Laughter)

7. Teaching option pricing is “totally nonsense”

WARREN BUFFETT: Well, let’s go to number 5. (Laughter)

AUDIENCE MEMBER: Good morning. I’m Joe Hutchin (PH), a shareholder from Culver, Indiana. Could you please comment on how you use stock options when trying to enter or exit a position in a public company?

WARREN BUFFETT: Yeah. We’ve — I think there’s one time we sold a put on Coca-Cola with the idea that, if it got exercised, we were very happy to own more Coca-Cola. It didn’t get exercised. We would have been better off if we had just bought the stock. Usually, if you want to buy or sell a stock, you should buy or sell the stock. And using an option technique to buy a call on a stock instead of buying the stock outright with the idea that you get it a little cheaper that way means that about four times out of five you’ll be right and the fifth time the stock will have moved earlier and you’ll have missed, you know, the transaction you wanted to have. And so we virtually have never used options as a way to enter a position or exit a position, and I would doubt very much if we do. We’ve used — we’ve sold these equity — long-term equity put options that were described in the press release yesterday and were described in the annual report, but that’s a different sort of thing.

If we want to buy something, we’ll just start buying it. And if we want to get out of it, we’ll start selling it. And we won’t get involved in any fancy techniques. Charlie?

CHARLIE MUNGER: Well, if I remember right, you wrote a letter when the public authorities were deciding whether we should have option exchanges for stocks. And Warren was all alone at that time, and he wrote a letter saying that he didn’t think it would do any good at all for the country to throw out the margin rules in this fashion. I’ve always thought that Warren was totally right. We — it’s — the idea of turning financial markets into gambling parlors so the croupiers can make more money has never been very attractive to us.

WARREN BUFFETT: Yeah. (Applause.)

WARREN BUFFETT: Yeah. It’s very interesting to me when I talk to these MBA students. One of them from the University of Chicago, the very first question I got a few years ago, he says, “What are we being taught that’s wrong?” I love questions like that. I have to plant them in the future. The amount of time spent at business schools — maybe it’s a little less now — but teaching things like option pricing and that sort of thing, it’s totally nonsense. I mean, you need two courses in a business school: one is how to value a business, and — from the standpoint of investments — how to value a business and how to think about stock market fluctuations. But the idea that you would spend all of this time with formulas — but the problem, of course, is that the instructors know the formulas, and you don’t when they come, and so they’ve got something to fill the time explaining to you.

And, you know, it is no fun if you — I mean, if you were teaching Biblical studies, you know, and you could read three or four of the most important religious tomes forward and backward in five different languages, you would hate to tell somebody that it comes down to the Ten Commandments. I mean, any damn fool can do that. So there’s a great desire of the priesthood in finance to want to teach the things that they know and you don’t know and that they spent a long time learning and that maybe requires a fair amount of mathematics. And it really has nothing to do with investment success. Investment success depends on buying into the right businesses at the right price. And you have to know how to value businesses, and you have to have an attitude that divorces you from being influenced by the market. You want the market there, not to influence you, you want it there to serve you. And that requires a mindset, which goes back to an earlier question, and it’s a mindset that’s described quite well in Chapter 8 of “The Intelligent Investor.”

8. Buffett praises sister Doris for her “retail” charity

WARREN BUFFETT: Let’s go to number 6.

AUDIENCE MEMBER: Hi. I’m Irene from Bonn, Germany. Both of you are very generous person. What is your joy of giving, and what are the potential pits when donating money — pitfalls when donating money? I’m sorry.

WARREN BUFFETT: The joys and giving and the pitfalls of donating money, huh. The — I know personally I’ve never given up anything in my life that made a difference in my life. I mean, there are people that will go to church this Sunday and they will drop money in a collection plate, and it will make the difference about where they take their family, or whether they take their family, in terms of where they eat, whether they go to a movie, whether they get an extra present at Christmas, whatever it may be. I mean, they are giving some money that makes a difference in their lives. I’ve never given a penny that way, and I never will. I mean, I get to do everything I want to do in life. But because I’ve lived a long time — which gives you an enormous advantage in terms of accumulating money — and most of the things I want in life don’t come from the expenditure of money. So it accumulates, and basically I’m giving away excess. I’m not giving away anything from necessity.

So I really — you know, I think what I’m doing is useful with the money, but I don’t think it’s on a par at all with the actions of somebody that’s giving money that really makes a difference in how they or their children live. Those are really charitable people. I think my sister Doris is here. She has given away money that made a difference in her life. She gives away time, too. She gives away eight or ten hours a day, in terms of actually looking into the real needs of people, and giving them things beyond the money — giving them help and advice and somebody to talk to. And, you know, that’s real giving. And I admire her for it. I’m not emulating her. I mean, she is in the retail business of giving; I like wholesale much better. In terms of the pitfalls, you know, you can make mistakes in any area. But if you — you should give to things that you personally have an interest in and believe in, and that can be anything. I don’t — I’m not going to prioritize what should be done with gifts. Something you’re involved in.

Something you want to give your time to as well as money. But beyond that, I’ll let Charlie carry on.

CHARLIE MUNGER: Yeah. Regarding pitfalls, I would predict that, if you have an extreme political ideology, whether of the left or the right, you’re very likely to make a lot of dumb charitable gifts. (Laughter and applause)

WARREN BUFFETT: If you hang around Charlie like I do, you get the sunny side of life. I mean — (laughter) We ought to have that playing, “The Sunny Side of the Street.”

9. We don’t “tell the world how to run their business”

WARREN BUFFETT: Let’s go to number 7.

AUDIENCE MEMBER: Good morning. My name is Okosh Vajay (PH), and I’m from India. I worship Mr. Buffett for his philanthropy, and I do hope to serve the Gates Foundation someday. My question to Mr. Buffett is, what’s your level of involvement when one of your companies is faced with an ethical dilemma? For example, Fruit of the Loom’s competitors have sweatshops in Central America. So what do you do to ensure that you don’t fall into the same trap?

WARREN BUFFETT: Yeah. Well, we let our managers run their businesses. And we’ve got some terrific managers, not only in terms of ability, but I would say that what we have seen of the ethical standards of our managers has been extraordinary over the years. That doesn’t mean there isn’t — there aren’t slip ups here or there. But taken as a group, over decades, I think that I’m very happy, in effect, turning over the keys, not only to the financial performance of the business, but in terms of how they behave. And I would say that I think you’re quite wrong in terms of — Fruit of the Loom’s operations are conducted in absolutely terrific standards. John Holland is here. I’d be glad to have you meet with him later. But we — we’re proud of our businesses and how they operate. We do not give them elaborate guidelines. I write them a letter every two years, roughly, and I ask them to send me a letter telling who they think should be the successor if anything happened to them that night. I keep those letters around.

Fortunately, they don’t come into play very often. But I also tell them we’ve got all the money we need. It’s nice to have more money, but we’re not going to lack for money at Berkshire Hathaway. We don’t have a shred of reputation more than we need, and we never want to trade away reputation for money. So we give them that same message that was given in the movie, in terms of the Salomon situation, which is that not only do they behave in a way that conforms with the laws, but that they behave in a way where, if a story were written by an unfriendly but intelligent reporter, the next morning, in their local paper, they would have no problem with their neighbors, their family reading it. And we run that in the movie every year, just because we like the managers to keep getting that message all of the time. There is no pressure from Berkshire’s corporate office to report X dollars per — of earnings in any quarter.

They don’t give me budgets, so they don’t — there’s no feeling that they have to come through with given numbers or I’ll be embarrassed in public in terms of publishing earnings or anything of the sort. We have no incentives to cause people to do anything that would go against their conscience or play games or cut corners or anything of the sort. And, overall, I think it’s worked pretty well. It isn’t perfect. You can’t have 250,000 people in the city without having something going on at some point. And we do have 250,000 people working. But I’m not unhappy with our batting average. Charlie?

CHARLIE MUNGER: Yeah. And, of course, Fruit of the Loom does have foreign plants, and we have no rule against that at all. We’ve got quite a few foreign plants now. We don’t favor foreign plants. We just do whatever makes sense under the circumstances.

WARREN BUFFETT: Yeah, we had a shoe business I’ve written about in Maine, and we had wonderful, wonderful workers there. They were more productive than workers around the world. But the United States was producing, 20 years ago, roughly a billion pairs of shoes a year, and we were a nation of Imelda Marcoses. I mean, it was wild. And Brockton, Massachusetts, and you name the towns, revolved around the shoe business, as did a town called Dexter, Maine. And we bought that business. And we tried to compete. We had a good brand name. We had great workmanship. And we found out that it just plain wouldn’t work against — competing against — shoes produced in China. So now of the — it’s over a billion pairs of shoes a year used in this country. Basically they all come from outside the borders. And you’re going to see that. And factories in China, factories in Central America — they do not have exactly the norms that we have in this country. And, you know, that’s going to be the situation.

We are — we will not — we are not going to tell the world how to run their business in any great way. We — obviously we have some standards that have to be met, but we are not — they are not exactly the situation you are going to find in the United States.

10. Buffett dismisses higher raw material costs

WARREN BUFFETT: Number 8.

AUDIENCE MEMBER: Good morning. My name is Mike McGowan (PH). I’m from Pasadena, California. I’m a shareholder in both Berkshire and Wesco. I run a website called FinancialFoghorn.com, and I write about precious metals and things. And I’ve asked you questions in the past about silver, and I didn’t really get them answered. So I thought I’d ask about a different commodity this time. I read about the Chinese raising the price of tungsten, and I think about your comment last year in buying ISCAR. Will commodity price increases in things like tungsten affect the profitability of ISCAR? And would that be the reason you’re locating a plant in China to build machine tools? Thanks.

WARREN BUFFETT: Yeah. The reason the plant was built in China was to serve the Chinese market, which is large and growing. And we opened in Dalian late last fall. It’s nicer to be closer to the raw material, but it really had nothing to do with changes in the price of tungsten. Generally speaking, if you’re creating a higher value-added product, as ISCAR is doing, from a raw material, there may be three months, six months, of adjustment to changes in raw material prices. And obviously, with some commodities, if it gets high enough you get into substitutes. But there isn’t going to be any substitute for tungsten in the cutting tools, and there won’t be — you know, we tried some substitutes for crude oil in terms of gasoline or — not so — heating oil but then the substitutes like natural gas go up in price, too. So I think largely, in our businesses, raw materials get passed through. Now, we’re having a tough time, for example, in the carpet business in passing through the cost increases that we experience in oil-based raw materials.

But we would be having trouble — we probably would be having trouble in the carpet business regardless now because of the slowdown in residential housing. It does make it tougher. But over a period of time, our businesses are going to reflect raw material costs. You know, the candy here I have, this fudge, which I can hardly wait to get into, you know, it’s going to reflect sugar and cocoa and things like that over time. And if you’re running an airline, it’s going to reflect the cost of fuel. So you can have little squeezes here and there, but it’s not a big deal, and it certainly isn’t the reason that we went to China to locate the ISCAR facility. That facility — incidentally ISCAR — we have a number of people here from ISCAR, and families in some cases. That is — I had very high expectations for that when we bought it. It’s exceeded it in every way. It’s exceeded in terms of financial performance. It’s exceeded in terms of the human relations we’ve developed with the people. I mean, it was — I told you it was a terrific acquisition a few years ago.

It’s been a dream acquisition, and I know Charlie wants to add to that. (Applause)

CHARLIE MUNGER: Yeah. I would say that the short answer is that, while we don’t like inflation because it’s bad for our country and our civilization, that we will probably make more money over time because there is inflation.

11. Lots of work to find a better buy than Berkshire

WARREN BUFFETT: Go to number 9.

AUDIENCE MEMBER: Good morning. My name is Marc Rabinov from Melbourne, Australia. My question is, Berkshire has bought a lot of shares over the last 12 months in listed companies. Do you expect the return on these investments to be between 7 and 10 percent per annum over many years, which is, I would say, well below what Berkshire has achieved in the past?

WARREN BUFFETT: The answer to that is yes. (Laughs) The — we would be very happy if we could buy common stocks where our expectation over a long period, pretax, from a combination of dividends and capital gains — we’d be very happy if we thought it was going to be 10 percent, and we would probably settle for a little less than that. And there’s no question — absolutely no question — that returns from owning Berkshire will be less in the future than they have been in the past. There’s no question that we will not do as well with the common stocks at Berkshire that we own in the future as we have over the last, really, 40 years or thereabouts. We operate now in a universe of marketable stocks that — where we’re talking about companies with market caps of at least 10 billion but really, in most cases, to have a meaningful impact on Berkshire, we’re talking much bigger than that, maybe 50 billion and up. Well, that universe is not as profitable a universe to operate in as if you have the entire universe of thousands and thousands of companies. So we — if we — just take an example.

If we find a company with a market cap of 10 billion and we can buy 5 percent of it — and usually that’s what we can buy without disturbing things — we can have a $500 million investment. Let’s say it doubles over a period of time. That’s 500 million. You pay a 35 percent tax. You have 325 million. That’s less than two-tenths of 1 percent in terms of Berkshire performance. So our universe has shrunk enormously, and we will not do as well in that universe — remotely as well — as we would if we were the operating in a much wider universe and could do all kinds of things. We’ve found little things to do from time to time where we’ve made some money. I may refer to them a little later, a couple things. And they’re nice, but they don’t move the needle very much at Berkshire. So anyone that expects us to come close to replicating the past should sell their stock. I mean, because it isn’t — it isn’t going to happen.

And, you know, I think we’re going to get decent results over time, but we’re not going to get indecent results. And in this field we prefer indecent, but we’re not going to get them. Charlie?

CHARLIE MUNGER: I think you can take Warren’s promises to the bank. We are very happy making money at a rate in the future that is way less than the rate at which we made money in the past. And I suggest that you adopt the same attitude. (Laughter)

WARREN BUFFETT: Well, I wouldn’t condemn them to that. I think if you’re working with small amounts of money — I’ve talked —

CHARLIE MUNGER: Oh, yeah.

WARREN BUFFETT: Yeah. Then you may have something very much better to do with your money than to buy Berkshire. I mean, if you’re working with small amounts of money, and you want to put in significant amounts of time, and examine thousands of securities, you will find things that are more intelligent to buy than Berkshire. You know, we still think Berkshire is an attractive investment over a long period of time. We think that it stacks up reasonably well with other very large companies. We don’t think it’s the most attractive investment in the world, in terms of what you can find if you’re willing to go through those thousands of possibilities, which is what Charlie and I used to do many years ago. It’s not feasible for us to do it now and wouldn’t have any impact on Berkshire. What we really like at Berkshire is buying good-sized to very large first-class businesses with first-class management and just sitting there. Because the nice thing about that is you don’t have go from flower to flower. You can just sit there and watch them produce more and more every year and give you capital and you can buy more businesses.

That’s a nice formula. It’s a formula that will work, I think, for us. It won’t produce returns like the past.

12. PacifiCorp will follow regulators on Klamath River dam

WARREN BUFFETT: Number 10.

AUDIENCE MEMBER: (Inaudible). My name is Chu Chu (Inaudible), and I come here from the Klamath River, and I come here with a heavy heart. And I know this is a pretty light-hearted event, but I came here last year with a heavy heart, too. And I fasted for ten days driving over here to speak with you. And, you know, we really were disrespected last year, because one of your subsidiaries, PacifiCorp, has dams on the Klamath River that are creating toxic algae blooms, along with multiple other things. I won’t go into it too far. But I just come here today with a principle agreement between you and I, that you will sit down at the table and help us figure this out, help us make PacifiCorp accountable.

And being that I’m an indigenous American, and you’re a guest in my home as a European American, that you would do that in front of all your shareholders today in good faith, that you care, you know, as a philanthropist and you care about, you know, helping, you know, thirdworld countries, you know, fight poverty, disease, when you’re helping create it right here in the United States.

WARREN BUFFETT: You may not — you may not — last year we read the order under which we acquired PacifiCorp. And, actually, as you may know, I’m prohibited from actually making decisions in that — in the area of PacifiCorp. That was part of the public utility commission ruling when we bought it. But we have Dave Sokol here who can speak to that. I think the first dam was built in 1907, and we bought PacifiCorp a couple of years ago. But David — if Dave could go to a microphone, I think that — I think he could address the issues that you brought up. I don’t think we meant in any way to be disrespectful last year. Those of you who were here last year, we may have a difference of opinion on this, and incidentally there are strong differences of opinion, as I understand it, in your area about what should be done. And — well, I think I should have Dave make the explanation on it. Dave? Somebody want to put a spotlight on the —

DAVE SOKOL: Thanks, Warren. As you stated first, it would be inappropriate for Mr. Buffett to respond in any detail on this issue, because it’s part of the acquisition in 2006 of PacifiCorp. He specifically agreed in writing not to interfere with any decisions of our regulated assets within PacifiCorp. So having said that, these four dams that we operate on the Klamath River were built over the last 100 years. There are a whole series of issues in the Federal Energy Regulatory Commission relicensing process as to what should occur. These decisions, through that regulatory process, have been ongoing for eight years, and they won’t culminate for probably another six. Having said that, there are 28 various parties from federal, state, and local agencies, Native Americans, fishery folks, local landowners, that are party to a discussion as to what should or should not happen with these assets — and I left out the irrigators. Of those 28 parties, other than PacifiCorp, there are at least four different directions in which people think this process should go.

From our perspective, we will be pleased to find a resolution when the 28 parties agree as to how that resolution should go forward, how it would be funded, et cetera. Fundamentally, it’s up to the Federal Energy Regulatory Commission, state and federal regulators, in addition to them, and then our specific regulators in each of the six states that PacifiCorp operates in. So if public policy moves in a direction of dam removal, fish ladders, or maintaining the existing status quo, that would be the process in which we would go forward. We are working constructively with each of the various parties. We’ve met numerous times with each of the four tribes. And it’s a complicated situation and one that hopefully, over time, a cooperative resolution can be met. (Applause.)

13. Eat what you want and love what you’re doing

WARREN BUFFETT: Area 11, please.

AUDIENCE MEMBER: Good morning. I’m (inaudible) from Walnut Creek, California. Well, we learned something from the comic movie, but could you please expand on how do you maintain your good mental and physical health? (Laughter)

WARREN BUFFETT: Well, you start with a balanced diet. (Laughter) Some Wrigley’s, some Mars, some See’s, some Coke. Basically it — if Charlie and I can’t have a decent mental attitude, who can? I mean, we get to do what we love doing every day. We do it with people that are not only cheerful about it and like us, but they do their jobs extraordinarily — they like their jobs too. We’re forced to do virtually nothing we don’t want to. I have a trainer that comes three times a week. She — I think she’s probably here. And she may think I’m a little begrudging in that particular activity, but that’s only 45 minutes, three times a week. The rest of the time I am doing almost — well, I’m doing whatever I love, you know, day by day by day by day. And I do it, you know, in air-conditioned offices and, you know, with all kinds of help and it — I mean, how could you be sour about life, you know, being blessed in so many ways?

And then the amazing thing is that Charlie is 84; I’m 77. And we’ve slowed down, I’m sure, in a lot of ways, but we pretend we haven’t, and it doesn’t seem to bother us. (Laughs) We get along fine. Great partners, great managers, you know, great families. I — there’s just no reason to look at any minuses in life and to focus on that. It would be crazy. So we really do count our blessings because they’ve been many and they continue to come forth, and we’ll enjoy it as long as we can. There’s not much more to it than that. Charlie?

CHARLIE MUNGER: Well, I wish we were poster boys for the benefits of running marathons and maintaining a very slim bodily state and so forth. But as nearly as I can tell, neither of us pays much attention to any health habits or dietary rules — (laughter) — and it seems to have worked pretty well so far. I don’t think we can recommend it to everybody, but I, for one, don’t plan to change. (Laughter and applause)

WARREN BUFFETT: Really, from the moment we get up to when we go to bed at night, we get to do all kinds of things. We get to — associating with wonderful people is about as good as it gets. And, you know, we live — we’re biased, obviously — but we think we live in the best country in the world and have all kinds of good things. I mean, just imagine — (Applause.)

WARREN BUFFETT: We could have stayed in my grandfather’s grocery store, and it would have been hell. (Laughter)

CHARLIE MUNGER: By the way, this relates to the subject of corporate compensation. You’re in a job which you would pay to have, if that were the only way to get it, and you’re supposed to be an exemplar from other people — for other people. There’s a lot to be said for not paying yourself very well. (Applause.)

WARREN BUFFETT: He points that out to me regularly. (Laughs) Well, if you think about it, you know, the idea that CEO compensation represents a market system and that you have to pay some guy a $10 million retention bonus or something to stay around in the job that, you know, he’s been fighting to keep and stacking the board and everything so they keep him around. I mean, it’s — I don’t know of a CEO in America — I’m sure there are a few — but I don’t know of any that wouldn’t gladly do the job at half the price or a quarter of the price. And I’ve seen some that have left jobs paying them eight figures and nobody’s offered them anything, you know, a year later or two years later. I wonder where that wonderful market system is that is supposed to have all these bidders for their services. It’s really sort of ridiculous, I think. (Applause.)

14. Follow your passion and marry the right spouse

WARREN BUFFETT: Let’s go onto 12.

AUDIENCE MEMBER: Hi. I’m Richard Rentrop from Bonn, Germany. At the moment I attend high school and would like your wisdom on how to approach the question of what to do with the rest of my life. So — (Laughter)

WARREN BUFFETT: We prefer things a little more difficult than that if you’re got a — (Laughter)

AUDIENCE MEMBER: So, Mr. Buffett and Mr. Munger, if you were about to start all over again, what profession would you choose and why?

WARREN BUFFETT: Well, I would choose what I do because, A, I have fun at it. I’m reasonably good at it. You know, I meet a lot of interesting people through it. No heavy lifting. You know, it — it’s — it fits me. It doesn’t — but that — that’s not advice for you. I mean, you have to find out what really — what’s your passion in life? You know, it’s a terrible mistake to kind of sleepwalk through your life, because unless Shirley MacLaine is right, you know, it’s the only one you’re going to have. And the — so I’ve — I was very lucky in that I found my passion early. I mean, I — that’s not easy. You know, that takes some luck. It just so happened my dad was in a business at a very small office and he had a bunch of books down there. And when I would go down there on Saturday or after school, I would start reading those books, and it turned me on. And this was before Playboy actually existed.

(Laughter) And so, you know, that was just plain lucky, you know. If he’d been a minister, I’m not so sure I would have been quite so enthused about visiting the office. (Laughter) But that’s the way to go. And I can’t prescribe that for you. But I can tell you that if you’re going through the motions in life, you’re doing something — now, obviously, if you need the job you have and you can’t make a change and your kids have to eat and all of that, you deal with realities like that. But when you’re in a position to make choices, you know, I always tell the kids that come visit me, I tell them, “Go to work for an organization you admire or an individual you admire.” That means many of them become self-employed, but they — (Laughter) The idea — you know, you can’t get a bad result. I went to work for Ben Graham when I was 24. I only worked for him for less than two years, but I jumped out of bed every day in the morning.

I was excited about what I was going to do. I was learning things. I was with a man I admired. I never asked my salary when I took that job. I moved to New York City and found out what my salary was when I got the check. So just be sure you — and be sure and get the right spouse. That’s enormously important. You know, as Charlie says, the problem, you know, is that we talk about that fellow that spent 20 years looking for the perfect woman, and then he found her, and unfortunately she was looking for the perfect man. So you may have a problem in that respect. (Laughter) But it’s enormously important who you marry. I mean, it’s a huge, huge, huge decision. And, you know, if you’re lucky in a couple things like that, you’re going to have a happy life. And you’re going to behave better as you go along.

I mean, it’s a lot easier to behave well when things are going your way and you are enjoying your work and you like the — you’re thinking about things every day that are the kind of things that you like to think about. And Charlie has a lot better advice than I have about it. Go to it.

CHARLIE MUNGER: Well, of course, you’ll do better if you develop a passion for something in which you have a considerable aptitude. I think if Warren had gone into the ballet — (laughter) - nobody would have ever heard of him.

WARREN BUFFETT: Oh, I think they’d have heard of me, just in a different way, Charlie. (Laughter) Well, the chances are, if you find something that turns you on, you probably do have some talent for it. I mean, it — I never — I don’t think I could have gotten turned on by ballet. (Laughs)

15. How Buffett overcame his fear of public speaking

WARREN BUFFETT: Let’s go — we’re going to go now to 13, which is in an adjacent ballroom. We have multiple overflow rooms, which is how we’re handling the 31,000. The grand ballroom is the only one we’ve got a microphone in. So let’s go to number 13. Somebody there?

AUDIENCE MEMBER: I’m Nancy Ancowitz. I’m from New York City, and I teach at New York University. Mr. Buffett, I’d love to get your advice on something that’s a little off the investing path but that taps into your business experience and wisdom. I’m writing a book to help people of a more introverted nature get the recognition they deserve. What advice would you give to the quieter half of the population to help them raise their visibility in their careers?

WARREN BUFFETT: Well, that’s a very good question. And I sort of faced that at one time. I was absolutely, throughout high school and college, terrified of public speaking. And I would have — I avoided any classes, signing up for them, that would require it. I would get physically ill if I even thought about having to do it, let alone doing it. And I took a Dale — well, I’ve — first of all, I signed up — I went down to a Dale Carnegie course when I was at Columbia, and signed up for it, gave him a check for a hundred dollars, went back to my room and stopped payment on the check. (Laughter) This is a real man of courage you’re looking at up here. (Laughter) And then I came out to Omaha, and I saw a similar ad. It was at the Rome Hotel, for you oldtimers in Omaha, on 16th Street. And I went down there, and this time I took a hundred dollars in cash and gave it to Wally Keenan, who some of you may know. He died some years ago. First time I’d met him.

And I took that course, and when I finished that course, I went right out to the University of Omaha and volunteered to start teaching, knowing that I had to get up in front of people. I think the ability to communicate, both in writing and orally, is of enormous importance, under taught. Most graduate business schools, they wouldn’t find an instructor to do it because it would sort of be beneath them to do something so supposedly simple. But if you can communicate well, you have an enormous advantage. And to you, who are talking to the group of introverted people — and, believe me, I was in certain ways quite introverted — it — you know, it’s important to get out there and do it while you’re young. If you wait until you’re 50 it’s probably too late. But if you do it while you’re young, just force yourself into situations where you have to develop those abilities. And I think the best way to do that is to get in with a whole bunch of other people who are having equal problems, because then you find you’re not alone, and you don’t feel quite as silly.

And, of course, that’s what they did at the Dale Carnegie course. I mean, we would get up in front of 30 other people who could hardly give their own name, and after a while we’d find that we could actually pronounce our own name in front of a group. But we would stand on tables and do all kinds of silly things, just to get outside of ourselves. You may have thought — by this point you may think it went too far in my particular case, but that’s another problem. (Laughs) But you’re doing something very worthwhile if you’re helping introverted people get outside of themselves. And working with them in groups, where they see other people have the same problem and they don’t feel quite as silly themselves, I think is — I think you’re doing a lot for some human beings when you help them do that. Charlie?

CHARLIE MUNGER: Yeah. It’s a real pleasure to have an educator come who is working to do something simple and important instead of something foolish and unimportant. (Applause)

WARREN BUFFETT: I hope he’s not going to name names. (Laughter)

16. Klamath River dam economics

WARREN BUFFETT: OK. Let’s go back to number 1.

AUDIENCE MEMBER: Hi, Mr. Buffett. My name is Regina Chichizola, and I’m the Klamath Riverkeeper. I came here today with many of the other people from the Klamath that came here, and I thank you for having us, and I thank the shareholders for being a lot nicer to us this year than they were last year. So my question is, I’m sure you’re familiar with the severe pollution issues in the Klamath River, such as the toxic algae problem that is 4,000 times allowable recreation levels, and that the fish are also now toxic due to the Klamath dams. I was wondering if you were familiar with the finances behind the Klamath dams? Many economic studies have shown that removing the Klamath dams would be up to hundreds of millions of dollars cheaper than relicensing them. So my question is, what would you do if PacifiCorp decided to keep these dams, even though it would mean that your shareholders would lose money in the long run and that PacifiCorp’s ratepayers would also be losing money?

WARREN BUFFETT: Well, I think the question about the ratepayers will be addressed by the public utility commissions. I mean, it is their job to represent the citizens of Oregon, and weigh a number of different considerations — for example, clean energy. Do you want to replace hydro energy with a — what you’re talking about — with coal, which emits carbons into the atmosphere? There are enormous tradeoffs. Anytime the government gets involved in eminent domain — we have that with wind farms, for example, in Iowa — there’s some people that are unhappy with us using the land for wind farms. But, on the other hand, you get clean energy that way. There are tradeoffs involved in government policy. You get into that with the question of eminent domain, all of that sort of thing. But I think I’m going to let Dave talk to the more technical questions you get into. But I would say, overall, you have people with widely different interests. Obviously, a big interest is the cost of electricity.

And to some extent, every public utility commission that makes a decision on gas versus coal versus wind versus solar is making a decision based partly on the economics to their ratepayers, partly on their feelings about what is the best for society, and those commissions are appointed state by state to make those decisions. Now, in addition, in this case we have the FERC as it’s called, the Federal Energy Regulation Commission, that will also have to rule on it. They will listen to everybody. They’ll listen to you. They’ll listen to the 28 others that Dave mentioned. In the end we will do exactly what they say. I mean, as a public utility, if they tell us to put up — not put up coal, we will not put up coal. If they tell us to put up wind, assuming that there is a place where there is wind, we will put up wind. We follow the dictates of the regulatory bodies that tell us what to do. And in the end they give us a fair return on the assets employed, and we will get that return whatever the assets may be. If they tell us to put in coal assets, we’ll get a return out of that.

So from our standpoint, from the standpoint of profitability, it’s neutral. From the standpoint of society, weighing all these different things, that’s a decision society will make. But, Dave, let’s — do you want to talk to the algae question?

DAVE SOKOL: Sure. First, it’s important, the Karuk tribe did do a study and found bioaccumulation of microcystins, or blue-green algae, in the perch and the fresh water mussels in the Klamath River. What’s important to understand about that — and by the way, we disseminated that report immediately to state and federal health agencies because they should know about it. Microcystin is not unique to the Klamath River. There are 27 other lakes in the state of Oregon that have blue-green algae, 70 different countries, every province in Canada, and 27 of the U.S. states have lakes that have blue-green algae. It is created from lakes that have a high abundance of nutrients and naturally-forming algae. And at the head of the Klamath River is a lake known as Upper Klamath Lake, which is actually a Bureau of Reclamation reservoir — it’s a shallow, large reservoir, that is known as being hypereutrophic, which means a great abundance of algaes and various nutrients.

Those nutrients then flow down the river and do pass through or, in cases, get backed up by the four reservoirs down below the Bureau of Reclamation-linked dam. The important issue is those things are, in fact, taken into account by the Federal Energy Regulatory Commission. They issued their environmental impact statement last November, which endorsed various fish passage methods on the dams but do not call for removal of the dams. But, again, those are decisions that all the state, federal, agencies, and the various involved parties will either have to come to agreement with or let them run their course through the FERC process.

17. Long-short strategy wasn’t a big money maker

WARREN BUFFETT: Thank you. Number 2.

AUDIENCE MEMBER: Hi. My name is Henry Pattener (PH). I’m hailing from Singapore, most recently. In one of your older letters, you — your older partnership letters in 1964 — you introduced a fourth investment method called “Generals — Relatively Undervalued.” In your description you say, “We have recently begun to implement a technique which gives promise of very substantially reducing the risk from an overall change in valuation standards. “We buy something at 12 times earnings when comparables or poor-quality companies sell at 20 times earnings, but then a major revaluation takes place so that the latter only sell at ten times.” Is this technique pair trading and, if so, how did you think about and calculate the ratio of longs to shorts?

WARREN BUFFETT: Yeah. I didn’t remember we started as early as ’64, but certainly in the ’60s we did some of what, in a very general way, would be called pair trading now, which is a technique that’s used by a number of hedge funds, and perhaps others, that go long one security and short another, and often they try to keep them in the same industry or something. They say that British Petroleum is relatively attractive compared to Chevron or vice versa, so they long one and short the other. And actually that technique was employed first by Ben Graham in the mid-1920s when he had a hedge fund, oftentimes — I read articles all the time that credit A.W. Jones with originating the hedge fund concept in the late ’40s, but Ben Graham had one in the mid-1920s — and he actually engaged in pairs trading. And he found out it worked modestly — very modestly — well because he was right about four times out of five but the time he was wrong tended to kill him on the other four. We did — we shorted out the general market for about five years in the partnership, to a degree.

We borrowed stocks directly from some major universities. I think we were probably quite early in that. We went to Columbia and Harvard and Chicago and different places and actually arranged for direct borrowing. They weren’t — it wasn’t as easy to facilitate in those days as it is now. And so we would take their portfolios and we would just say, “Give us any of the stocks you want, and then we’ll return them to you after a while and we’ll pay you a little fee.” And then we went long things that we thought were attractive. We did not go short things that we thought were unattractive; we just shorted out the market generally. It was always kind of interesting to me, when I would visit the treasurer of Columbia or something like and I’d say, “We’d like to borrow your stocks to short,” and, you know, he thought his stocks were pretty good at that point. And he’d say, “Which ones do you want?” And I said, “Just give me any of them — (laughs) — I’m happy to short your whole damn portfolio.”

(Laughter) I needed the Dale Carnegie course to get me through that kind of thing, you know. We didn’t have any specific ratios in mind. We were always limited by the number of institutions that would give us the stocks to short. So it was not a big deal, but we probably made some extra money on it in the ’60s. It’s not something that would fit our — what we do these days at all. And, generally speaking, I think if you’ve got some very good ideas on businesses that are undervalued, it’s really unnecessary to do any shorting out of the market. There’s a — for those of you who are in the field — I mean, there’s a — kind of a popular proposal — money managers always have some popular proposal that’s being sold to the potential investors — and now there’s something called 130-30, where you’re long 130 percent long, short 30 percent. That stuff is all basically a bunch of stuff just to try and sell you the idea of the day. It doesn’t really have any great statistical merit. But the fish bite, as Charlie says.

Charlie can elaborate on that.

CHARLIE MUNGER: Yeah. We made our money by being long some wonderful businesses. We didn’t make it by a long-short strategy.

18. Big opportunities often don’t last long

WARREN BUFFETT: Number 3.

AUDIENCE MEMBER: Dear Mr. Buffett, dear Mr. Munger. My name is Oliver Krautscheid from Frankfurt in Germany. The subprime crisis has led to inconsistent pricing in capital markets. Credits are trading at large discounts, and at the same time, the equities do not reflect this. My question is, when will this be over, and how do you take advantage of market dislocations?

WARREN BUFFETT: Well, when there are market dislocations, there are always ways to take advantage of it, but we’ll leave for you the joy of searching for those. But there have been some really important dislocations. And I brought along, just for your amusement, a few figures on something that we’ve done recently. But it doesn’t have any big significance for Berkshire. I mean, Berkshire will make some extra money out of this. It doesn’t take any time to think about. But it does illustrate just how dramatic the changes were. And the ones I brought along relate to the tax-exempt money market funds. There were 330 billion of these. That’s a lot of money — 330 billion. And they relied on repricing of — really, in almost all cases — first-grade municipal bonds. Every seven days they have these auctions, and it was all set up very elaborately so that people could have their money, more or less, in their minds, instantly available and something that was tax exempt, and they were marketed extensively.

And I brought along — for example, here’s one that related to the — they were backed by various municipal issues. This one happens to be one by the LA County Museum of Art. Just pulled that out. And on January 24, it was marketed at 3.15 percent; January 31, 4.0; February 7, 3.5; February 14, 8 percent. Now, how can a tax-exempt bond of short-term nature be selling at a 3 1/2 percent rate one week, and one week later on Valentine’s Day be at 8 percent, and one week after that be at 10 percent? It’s now back to 4.2 percent. Now, those are huge dislocations in markets. That’s crazy. It would be one thing to be some little obscure item, but this happened with billions and billions and billions of dollars of securities. It even happened — we get these bid sheets every day, and this happens to be a bid sheet, I think, from Citigroup. And they were repricing these every seven days.

And what you would find on these — you’ll see there’s lots of issues involved — the same issue would appear on several different pages, because it would represent some different auction, although handled by the same broker at the same time. On one page you would find an issue — we would bid all these — we happened to bid these at 11.3 percent. On one page, we bought them at 11.3 percent. On another page, the same issue, we bid the 11.3 percent and somebody else bid 6 percent. So you have the same issue with the same broker at the same time being sold at 11.3 percent and 6 percent. Those are marks of extreme dislocation, and you find those occasionally. You found that after the Long-Term Capital Management crisis is 1998. You found the equivalent of it in the stock market in 1974, and so on. And those are great times to make unusual amounts of money. And if you — there’s certain things we can’t figure out. I see — in the Wall Street Journal — I see advertisements these days of auctions taking place in some esoteric mortgage securities.

If you had enough time, you could probably figure out some of those that were very mispriced. We don’t fool around with that. We just don’t have the time. We were able to do four — we have about 4 billion in this right now. When we get all through, we’ll have made some extra money for a couple of months. It won’t be significant, in relation to Berkshire’s size, but it’s something that’s very easy to do. You may be able to find — by working very, very hard on some smaller issues — you might be able to find in this mess in mortgages — and it’s gone beyond subprime. It’s gone into Alt-As and it’s gone into Option ARMs and that sort of thing. There very well could be some great opportunities out there that Charlie and I will no longer spot because we just can’t be looking at that many things. Charlie?

CHARLIE MUNGER: Yeah. What is interesting is that — how brief these opportunities to take advantage of dislocations frequently are. Some idiot hedge fund bought unlimited municipal bonds at, you know, incredible margins. I think they bought 20 times more municipal bonds than they could afford with their own money, borrowing all the rest. And when those things were dumped on margin calls, municipal bonds suddenly got mispriced in America. But the dislocation was very brief. So you —

WARREN BUFFETT: But very extreme.

CHARLIE MUNGER: But very extreme.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: So if you can’t think fast and act resolutely, it does you no good. So you’re like a man standing by a stream trying to spear a fish and the fish just comes by once a week or once a month or once every ten years. And you’ve got to be there to throw that spear fast before the fish swims on. It’s a pretty demanding business if you do it right.

WARREN BUFFETT: But there have been times. I mean, in the junk bond market, there was a three- or four-month period in 2002 where some really incredible things happened and they happened on a large scale. So —

CHARLIE MUNGER: Yeah. It happens about twice a century.

WARREN BUFFETT: Yeah. (Laughter) Which means he and I have only had four or five times when we could do it. (Laughter)

19. “Automatic formula for getting ahead”

WARREN BUFFETT: Let’s go to number 4.

AUDIENCE MEMBER: Hello, Mr. Buffett and Mr. Munger. My name is Svinneyvaz Canadival (PH). I’m from Fort Lauderdale, Florida. I read all your letters and annual reports multiple times, and every time I get a different insight. So thanks for doing it. My question is about converting the successful small businesses into large enterprise. I have a good and successful small business from the last few years, and I’m unable to grow it to the next level. It seems like there are some components are missing, so I wanted to take your advice on it.

WARREN BUFFETT: Well, Berkshire was a small business at one time. I mean, it just takes time. I mean, it’s the nature of compound interest. You know, you can’t build it in one day or one week. So Charlie and I — you know, we’ve never tried to do in some master stroke — convert Berkshire into something four times as large. People have done that sometimes in business. But we’ve sort of felt that if we kept doing what we understood, and did it consistently, and had fun while we were doing it, that it would be something quite large at some point. But there’s nothing magic — it would be nice to attract a whole bunch of money into some great idea and have it — you know, multiply it manyfold in a few weeks or something of the sort. But that has really not been our approach. We have just — we have done — in a general way, we’ve done the same thing. Now, we do little variations of it, but we kept doing the same thing for years and we’ll keep doing it.

You know, we will have more businesses a few years from now than we have now. And we’ll have all the ones we have presently. Most of them will do better. Some won’t. And we will have added something. And that’s an automatic formula for getting ahead, but it’s not an automatic formula for galloping ahead. But we don’t really feel — we’re not unhappy because we’re not galloping. We’re not happy if we’re not moving at all. But, you know, we’ve got 76 or so, in most cases, pretty darn wonderful businesses. And, like I say, we’ll have more as we go along. So it’s a very simple formula. Gypsy Rose Lee said once — she said, “I have everything I had five years ago. It’s all that it’s 2inches lower,” you know. Well, what we want to have five years from now is a whole bunch of businesses we had before that are 2-inches higher, plus some more businesses. And that’s the formula. Charlie?

CHARLIE MUNGER: Yeah. You’ve got to remember that it’s the nature of things that most small businesses will never be big businesses. It’s also in the nature of things that most small — most big businesses — eventually fall into mediocrity or worse. So it’s a tough game out there. In addition, the players of the game all have to die, and that is — those are just the rule of the game, and you have to get used to it. We’ve only created from scratch one small business that became a huge business that I can think of, and that’s the reinsurance department. And there, Warren and Ajit and others have created a great and valuable business out of air. But can you think of anything other that’s large that we’ve done in all these decades?

WARREN BUFFETT: No. No.

CHARLIE MUNGER: We’ve only done it once, so we’re a one-trick pony.

WARREN BUFFETT: Yeah. We were lucky on that one, too. (Laughter) Yeah, and incidentally, without Ajit we wouldn’t have done it at all.

CHARLIE MUNGER: Right, right.

WARREN BUFFETT: It isn’t that we did it. Ajit did it. We just sat there cheering.

CHARLIE MUNGER: Somebody asked us once what was the best investment we ever made, and I answered the fee we paid to the executive recruiter to find Ajit Jain. (Applause.)

20. Bond insurance business off to strong start

WARREN BUFFETT: In that connection, I’d like to give you a little report. We went into the municipal bond insurance business a few months ago, and naturally, we did it through Ajit. And he got our companies up, licensed, and running. And in the first quarter of 2008 — I don’t have the figures for all the other people — but our premium volume came to over $400 million. And I think — now, that was overwhelmingly written in the secondary market, but I think our premium volume was not only larger than any other municipal bond insurer in the United States, I wouldn’t be surprised if it’s as large as all of the rest of them combined. And this was from a standing start that Ajit accomplished this. And I have here a list of, what, 300 and — this is the end of the quarter — 278, I believe it is, transactions. Now, that’s all done out of an office with 29 or 30 people who are doing a lot of other things, too. I mean, it’s a remarkable, remarkable place.

One of the interesting things about this is that almost all of this business — although not all the premium volume — all of — almost all of this business was — came from people who came to us with municipal bonds asking us to insure them, and in every case, except two or three, they already had insurance from the other bond insurance, most of whom are rated triple-A. So they were paying us a fee which was higher to write insurance which would only be paid, not only if the municipality didn’t pay, but the original bond insurer didn’t pay. So we were writing business at an average rate of two and a fraction percent for the quarter, and the original insurer had charged, perhaps, an average of 1 percent. And they had to pay and they — in fact, the only way we’re going to pay is if they went broke. So it tells you something about the meaning of triple-A in the reinsurance — in the bond insurance — field in the first quarter of 2008. Ajit has done a remarkable job in this arena.

And Berkshire wrote a couple of primary policies for the Detroit Sewer District and the Detroit Water District that — each about 370 or 380 million — and people have found our insured bonds trading in the secondary market at a more attractive yield to the issuer. In other words, at lower yields than from any other bond insurer. So this whole company has been built, just in a matter of a couple of months, by Ajit in his small office in Connecticut. It’s pretty remarkable, and I congratulate him for it. (Applause.)

21. We prefer “the business which drowns in cash”

WARREN BUFFETT: Let’s go to area 5, please.

AUDIENCE MEMBER: Hello. My name is Stuart Kaye, and I’m from New York City. I wanted to know, if you could not talk with management, could not read an annual report, and did not know the stock price of a company, but were only allowed to look at the financial statements of a company, what metric would you look at to help you determine whether you should buy the company?

WARREN BUFFETT: Well, what we’re doing in investment, and what everybody is doing in investment, is they’re laying out money now to get more money back later on. Now, let’s leave the market aspect of the asset out. I mean, when you buy a farm, you really aren’t thinking about what the market on it’s going to be tomorrow or next week or next month. You’re thinking about how many — what the — how many bushels of beans per acre can you get or corn per acre and what the price is likely to be. You’re looking to the asset itself. In the case you lay out, the first question you’d have to make is do I understand enough about this business so that the financial statements will tell me the information that’s useful to me in making a judgment about what the future financial statements are going to look like. And in many cases, the answer would be no. Probably in a great majority of the cases it would be no.

But I’ve actually bought stocks the way you’re describing many times, and they were in businesses that I thought I understood where, if I knew enough about the financial past, it would tell me enough about the financial future that I could buy. Now, I couldn’t say the stock was worth X or 105 percent of X or 95 percent of X, but if I could buy it at 40 percent of X, I would feel that I had this margin of safety that Graham would talk about, and I could make a decision. Most times I wouldn’t be able to make it. I wouldn’t know — if you hand me a bunch of financial statements and you don’t tell me what the business is, there’s no way I could make a judgment as to what’s going to happen. It could have been a hula hoop business; it could have been a pet rock business. You know, on the other hand it could have been Microsoft early on. So unless I know the nature of the business, the financial statements aren’t going to tell me much, you know.

If I know the nature of the business and I see the financial statements, you know, if I see the financial statements on Wrigley, I know something about the business. Now I have to know something about the product before I can make that judgment. But we’ve bought lots and lots of securities. The majority of the securities Charlie and I bought, we’ve never met the management and never talked to them, but we have primarily worked off financial statements, our general understanding of business, and some specific understanding of the industry in the business we’re buying. Charlie?

CHARLIE MUNGER: Yeah. I think there’s one metric that catches a lot of people. We tend to prefer the business which drowns in cash. It just makes so much money that the main — one of the main — principles of owning it is you have all this cash coming in. There are other businesses, like the construction equipment business of my old friend John Anderson. And he used to say about his business “You work hard all year, and at the end of the year there’s your profit sitting in the yard.” There was never any cash. Just more used construction equipment. We tend to hate businesses like that.

WARREN BUFFETT: Yeah. It’s a lot easier to understand a business that’s mailing you a check every month. But that’s what an apartment house — you know, if you own — you can probably value an apartment property pretty well if you know anything about, you know, the city in which it’s in. And if you have the financial statements, you could make a reasonable guess as to what the future earnings are likely to be. But that’s because it is a business that gives you cash. Now, you can — there can be surprises in that arena as well. But I’ve bought a lot of things off financial statements. There are a lot of things that I wouldn’t buy, you know, if I knew the — actually, there are a lot of businesses I wouldn’t buy if I thought the management was the most wonderful in the world because, if they were in the wrong business, it really doesn’t make much difference.

22. Pollution in Klamath River

WARREN BUFFETT: Number six?

AUDIENCE MEMBER: Good morning. My name is Mike Palmateer (PH), fisheries supervisor for Karuk Fisheries. Mr. Buffett, you grew up and still live in the banks of the Missouri River. I, too, live on a river called the Klamath. My family has lived there since time immemorial. In 2002, 68,000 fish died at the mouth of the Klamath River due to disease and bad water quality. These fish are also my relations. If another company polluted your river and killed all the fish and made the river unswimable and unfishable, how would you approach this problem? Thank you.

WARREN BUFFETT: Well, I think society would — as a whole — should approach that problem by looking at the net benefits from whatever is taking place in that situation and what the costs of electricity would be and what the farmer’s situation would be if he went to a different form of water distribution. I mean, there are a lot of competing ideas and desires in a large society, and it’s up to government, basically, to sort out those. We’re sorting it out — right now, we’re building coal plants in the country. We’re building gas plants. We’re doing various things. People are coming to different conclusions about what kind of tradeoffs they want to make, and generally these are being made at the state level, although you could have a national energy policy that would override individual states’ decisions. We’re responsive to national policy on that. We’re responsive to local policy.

The Oregon Public Utility Commission, I’m sure, is aware of exactly what you’ve discussed and they have to consider that, but they have to consider a lot of other things in determining what is the best way to generate the electricity required for the citizens of Oregon. And, Dave, would you want to add anything to that?

DAVE SOKOL: Warren, just one comment. And not in any way to be disrespectful of the fishermen, but it — we are not polluting the river. We’re not doing — adding — anything to the water that isn’t coming out of Upper Klamath River, and we do recognize the different views as to whether the irrigation is a good thing or a bad thing, whether renewable power such as hydro is better than returning the river to its prior 1907 date. But the one thing that — just to be clear — is that PacifiCorp is not adding anything. The water is flowing through penstocks, creating electricity, and coming out the rear end, and it did so under a 50-year FERC license. Again, we understand the varying concerns, and hopefully, over the next six years a societal answer that balances all those concerns will be reached.

WARREN BUFFETT: Thank you. (Applause.)

CHARLIE MUNGER: I’d like to — I’d like to point out how refreshing it is to have people addressing a pollution problem which has nothing to do with burning carbon. (Applause.)

23. Buffett’s advice to a 12-year-old

WARREN BUFFETT: Number 7.

AUDIENCE MEMBER: Hey. I’m Jack Range (PH). I’m from Philadelphia. I’m in seventh grade, and I’m 12-years-old. I just wanted to ask, what kind of things should I be reading, like, in my grade? ’Cause I know there are a lot of things that they don’t teach you in school that you should know, but what things should I be looking into? (Applause.)

WARREN BUFFETT: Well, I would get in the habit, if you don’t have it already — but you sound like you very well may — of reading a daily newspaper, which is not the most popular thing in the world among younger people these days. But you want to learn as much as you can about the world around you. And Bill Gates, I think, quit at the letter P in the World Book. Doesn’t seem to have hurt him too much to quit there. But you can have a set of World Books. You can read the newspapers. You should just sop it up. And you’ll find out what’s the most interesting to you. I mean, you know, there’s a certain point where the sports pages were most interesting to me, then the finance pages. I happen to be a political junkie. But you just can’t learn enough in life. And I think the fact — what you’ll find is the more you learn, the more you want to learn. I mean, it is fun, and — but you sound to me like a young person that’s going to do a lot of that on their own.

Do you have any suggestions, Charlie? You’d probably suggest reading Ben Franklin.

CHARLIE MUNGER: My suggestion would be that the young person that just spoke has already figured out how to succeed in life. You’ve got it made. (Applause)

24. “We never urge people to sell good businesses”

WARREN BUFFETT: Number 8.

AUDIENCE MEMBER: Greetings to all of you from the Midwest of Europe, from Bonn, Germany, on the Rhine River. I’m Norman Rentrop. I’m a shareholder in Berkshire, Wesco, and Cologne Re. I want to thank you and Eitan Wertheimer to take the initiative and the time to come to four cities in Europe, and potentially throughout the world, to tell owners of family businesses what great alternative Berkshire Hathaway is to selling their businesses to buyout funds. Now, my question regarding the chocolate industry. I’m challenged since I cannot buy See’s Candy in my hometown, Bonn, Germany. You gave that great example of the great business, the good business, and the gruesome business. See’s Candy, you cited, having sent, like, $1.3 billion in cash profits to Omaha. There’s another company called Lindt and Sprungli. Now, while See’s Candy achieves more than 20 percent profit on sales, you describe that their growth has been “OK.” Lindt and Sprungli does only 14 percent on sales, but they did go almost global.

WARREN BUFFETT: Yeah. Could you get to the question, please, on this? (Laughs)

AUDIENCE MEMBER: Yeah. The question is in — whether you want to have a company with high profitability but OK growth versus a company going global but lower profits? What are your considerations?

WARREN BUFFETT: It really makes no difference to us. We evaluate all kinds of businesses. And what we do want is we want a business with a durable competitive advantage, which both of the companies you named do. And we want something we understand. And we want a management that we like and trust. And then we want a price that makes sense. And we try to look at — we probably looked at every confectionary business, you know, for 20 years that was publicly owned where we got the figures. And sometimes we find something where we can take action, and most of the time we don’t. When they’re private businesses, we don’t determine — a really good private business — I always tell the manager, the best thing to do if you’ve got a wonderful private business is just keep it. It’s going to be worth more next year and the year after. So there’s no reason to sell a wonderful business except for kind of extraneous factors. It may be family situations. It may be taxes. It may be that there isn’t another potential heir or whatever it may be.

But there’s no need — if you’ve got a business worth a billion dollars, you don’t need the billion dollars — you’ve got a business that’s worth a billion dollars — any more than if you’ve got a farm that’s worth a million dollars. You’ve already got the million dollars. You just happen to have it in the farm. And if you like farming, you keep it. So we never urge people to sell good businesses. We urge them to keep them. But there comes times when they do want to sell for one reason or another — maybe once every 20 or 50 years — and we do think if they have a business that they’re enormously proud of — it’s a really fine business — that they can keep more of the attributes that they love in that business by selling it to Berkshire than they can, by far, selling it to anyone else. So we are the logical buyer.

As you mention, I’m going to Europe — Eitan, who’s been wonderful about setting this up — and we’re going to make presentations, not to try to get anybody to sell us their business now, because most people shouldn’t sell us their business now. But we do want them to think of us when the time comes when an event occurs that does cause them to think about selling. And we want to be on their radar screen. And we’re more on the radar screen in the United States than we are in Europe, and we’re going to try to correct that. But if you take a firm like you name, a Lindt, you know, there’s a price at which we would buy stock in Lindt. There’s a price at which we’d buy the whole business. But it’s unlikely to be selling there. You know, the — if you think about hundreds and hundreds of wonderful companies — I get all these managers that — just got a CEO yesterday who called me — and they want to tell me about their business, and they imply their businesses — or they think — their business is the most attractive investment in the world.

It isn’t the most attractive investment in the world. There are thousands of possible investments. And, you know, the idea that all these managers are saying “Our stock is the most wonderful in the world” is crazy. But it’s our job to look at hundreds of things and, in terms of marketable securities, buy what we think are the most attractive ones, among the ones we understand and like as a businesses. And then occasionally we get the chance to buy an entire business. We never do that at a bargain price. It just doesn’t happen. People don’t do that. The stock market gives you bargain prices; individual owners won’t. But when we get a chance to do that at a fair price, we like doing it. We love building Berkshire with a bunch of businesses with favorable long-term economic characteristics. But the chance that any one of them — you know, we aren’t going to look for a given confectionary company and say, “Regardless of price, we’re going to do this,” because we don’t do anything when the phrase “regardless of price” enters into the sentence. Charlie?

CHARLIE MUNGER: Yeah. I watched a man build up a business in southern California, which was a wonderful business. And the time came to sell it — and he devoted his whole life to creating it — he sold it to a known crook who was obviously going to ruin the business just because he could get a slightly higher price. I think that’s an insane way to live a life if you own a prosperous business. I think the better course is to sell to somebody you know is going to be a good steward of what you’ve created. (Applause.)

25. Dollar will probably weaken over time

WARREN BUFFETT: Let’s go to number 9, please.

AUDIENCE MEMBER: Hi. My name is Johann Freudenberg (Ph) from Germany. How would you, as a European investor that invests in U.S. equities, hedge the U.S. dollar risk? Thank you.

WARREN BUFFETT: How would I what?

CHARLIE MUNGER: How do you hedge the U.S. dollar?

WARREN BUFFETT: Oh. Well, whether you’re thinking about starting in Germany and hedging the dollar risk of investing here or vice versa, we are happy to invest in businesses that earn their money in euros in Germany, or whether it’s there, or France, or Italy, or earn their money in sterling in the UK, because we do not have a feeling — at least I don’t have a feeling — that those currencies are likely to depreciate in a big way against the U.S. dollar. That would be how we would get hurt. We could offset that by borrowing the money in those countries and borrowing in their currency to make the purchases. But, overall, I think that the U.S. is going to continue to follow some policies that have made the dollar weaker in recent years. So if I had to bet my life one way or another over 10 years, I would probably bet that the dollar would weaken against other major currencies, and, therefore, I feel no need — if we buy companies whose earnings primarily arise elsewhere in major countries — I feel no need to try and hedge those purchases.

I mean, if I landed from Mars today with a billion of Mars dollars or whatever they call them on Mars, and I was thinking about where to put my money, you know, I went to the local — wherever my UFO landed — and went to the bank and said, “I’ve got this billion of Mars currency,” and they said, “Well, what would you like to exchange here?” I don’t think I’d put all the billion in U.S. dollars. So it doesn’t bother me to buy businesses around the world, unhedged in terms of their currency, and have a fair amount of our earnings coming from earnings that originate in other currencies and which I will convert at current rates to dollars at some time in the future. If you take Coca-Cola — we own 200 million shares of Coca-Cola. And if their earnings are roughly $3 a share, that means our share of the earnings of Coca-Cola are $600 million a year. And of those earnings of 600 million, you know, maybe close to 500 million will be from around the world — all different kinds of currencies. Basically I like that.

I think that that will be a net plus to us over time, and it certainly has been a net plus to us in recent years. So we are not in the business of hedging currencies, basically. We do not have a lot of hedges set up. Charlie?

CHARLIE MUNGER: Nothing to add.

26. Small stocks and mispriced bonds offer opportunities

WARREN BUFFETT: Number 10.

AUDIENCE MEMBER: Hey. How you doing? I’m Eric Schline (PH) from Larchmont, New York. This is actually a follow-up question from a question that I asked last year at the meeting. I’d asked you guys, you know, what you would do with small sums of money since — you know, I run a small portfolio, under a million dollars. And I asked you if you’d be doing things, you know, like the net-nets that Benjamin Graham used to talk about and, you know, liquidation arbitrage. You know, a lot of things you used to do at the Buffett Partnership. And you acknowledged that you wouldn’t be just a buy-and-hold investor, that you — as you are today — but we would be doing a lot of those transactions. And, Mr. Buffett, you also talked about how a lot of the investments you would do with under a million dollars would have nothing to do with stocks and would be with other types of securities, and you really don’t elaborate — neither of you really elaborated any more than that.

So I guess I was wondering if you could elaborate a little bit more on how your investment strategy, you know, back then, you know, in reference to non-stock investments, would be different than your buy- and-hold strategy today? So what kind of stuff would you be doing? Maybe you could give me a past example that you did in the ’50s and the ’60s. That would be great. Thank you. Appreciate it.

WARREN BUFFETT: Well, if I work with small sums of money — and I’d be happy doing that — it would just open up thousands of possibilities to me. And you might very well — certainly we found very mispriced bonds, where we could come nowhere near buying a position of enough size in Berkshire to make a difference, but where it would have made a difference if you were working with a million dollars. But it would be bonds. It would be stocks of both in the United States and elsewhere. We found them in Korea a few years ago that were ridiculously cheap. You know, you basically had to make very significant returns, but you couldn’t put big money on it. So it could be in stocks. It could be in bonds. It wouldn’t be in currencies with small amounts. But, you know, I had a friend who used to buy tax liens — you know, Tom Knapp, he’s got some relatives here. An enterprising person can find a lot of different ways to make money. You’ll find most of them will be in small stocks.

If you’re working with small money, they’ll be in small stocks or in some specialized bond situations. Wouldn’t you say that, Charlie?

CHARLIE MUNGER: Sure. (Laughter)

27. Pandering politicians behave better in office

WARREN BUFFETT: Number 11, please.

AUDIENCE MEMBER: Hi. I’m Dr. Silber from the Infertility Center of St. Louis. And we feel that by making many, many babies, we’re doing the best we can to help salvage the solvency of Social Security. (Laughs)

WARREN BUFFETT: We won’t pursue the logic of that too far. (Laughter)

AUDIENCE MEMBER: We need someone to pay into the system, and with the demographic implosion that we’re facing and the current anti-immigration feeling, that this is the real cause of the Social Security dilemma that we’re facing. And it’s true in most of the developed world. But my question is, everybody is looking very closely at what you and Charlie are going to say at this meeting because there’s just a huge amount of confusion since the credit crisis, and I guess you’ve been through many, many years and decades of confusion. But everybody really wants to know what you think, because we have three candidates, one of whom I like, which I won’t mention, but all three of whom seem to be pandering to voters and not really demonstrating a profound understanding of economics. And we’re going to decrease interest rates to help the credit crisis, and we’re going to inject $180 billion as free gifts into the economy, and yet our dollar is down 50 percent, and we certainly don’t want a recession and all the misery that would bring. But aren’t we going to eventually have a gigantic inflation here in the U.S.?

And so — in China, which is our major partner in this, the stock market has gone down and people are losing money because they’re worried about the U.S. So I’m wondering if you could just shed some words of wisdom on, if you were the presidential candidate — which I would like to see happen — what would be your position or your policy?

WARREN BUFFETT: Well, I think it was Bill Buckley that ran for mayor of New York, you know, 40 years ago or something like that, and they asked him what the first thing he would do if he were elected. He said, “I’d ask for a recount.” (Laughter) It’s not an easy game. I think we have — just personally— I think we have three pretty good candidates this time — quite good candidates. But I think that your comments about the pandering and all that, I’m afraid that’s just part of — if you have a very long political process, and you have people only generally willing to listen to ideas in fairly short form, and you’re trying to make the other candidates look bad one way or another — I think that the truth is you do get a lot of pandering in the policies that are proposed. I think you have candidates that are pretty smart about economics. I happen to think two of the three are maybe a little smarter about economics than the third, but the third may be just as smart, too. They may just be forced into a different position.

You know, a political process is something that doesn’t lend itself to Douglas-Lincoln debates on the fine points of policy, and it’s a tough game. And I don’t — the one thing I think is I think they will behave better in office than on the stump. I think that’s true of all three of them, and I think — but I think that’s just built into the system. We — you know, we have a country that works awfully well. You know, whether Warren Harding is in office or Franklin Pierce, or whatever it may be over the years. And it gets back to that saying I’ve said many times that you want to buy stock in a business that’s so good that an idiot can run it because sooner or later one will. (Laughter) And we live in a country, frankly, that is so good that your children and grandchildren will live a lot better than you live, even though an idiot or two runs it from time to time in between. But we’ve got a lot better than idiots running. Believe me.

I think we’ve got three very good candidates, and I wish — whichever one of them wins, I wish them well. You know, it’s the toughest job in the world, the most important job in the world, and I think the motivations of the people running it are a lot better sometimes than their proclamations as they go along in the political process. I think it’s very hard to run in Iowa without being for ethanol. You know, it may be — you may win some badge for courage or something in the end, but you won’t win the presidency. Charlie?

CHARLIE MUNGER: Well, I’d like to address the recent turmoil and its relation to politics. After Enron totally shocked the nation with the gross amount of folly and misbehavior, our politicians passed Sarbanes-Oxley, and it has now turned out that they were shooting at an elephant with a pea shooter. And low and behold, we have a convulsion that makes Enron look like a tea party. And I confidently predict that we will have changes in regulation and that they won’t work perfectly. (Laughter) Human nature always has these incentives to rationalize and misbehave, and the learned professions very often fail in their basic responsibility to be learned. And we’re going to have this turmoil as far ahead as you can see.

WARREN BUFFETT: But look at it this way: I have a job here I love. You know, I’d gladly pay to have this job. Now, I have enough stock so that I’m reasonably assured of keeping the job, but let’s just assume for the moment that there are three other candidates out there, and none of us had any stock, and we were all up here making a pitch to you. My answers might have been a little different today, you know, in terms of what Berkshire’s prospects would be under me and all that sort of thing going forward. It’s a corrupting process. Now, you know, it works pretty well, but the process itself has to be corrupting. Just take the boom in commodity prices we’ve had. We’ve had a boom in the price of oil, but we’ve had a boom in the price of corn and soybeans. Now, I’ve heard no political candidate say you’ve had this huge increase in the price of corn and soybeans.

That means all these poor people throughout the country, they’ll be paying more for food, so we ought to put an excess profits tax on farmers. That is not something you’re going to hear. On the other hand, when it happens in oil and it happens to be Exxon, you know, people will propose occasionally we ought to put a terrible tax on Exxon because the price of oil has gone up. There’s a lot of situational ethics, or situational policymaking, that depends on how many voters there are in any given category and what state you happen to be in and all that. But I don’t think I’d behave any better. If my ambition were to be President of the United States, you know, I would — I’m sure it would affect my — what I talked about and my behavior. You know, we’re all human beings.

So I don’t condemn the people for the fact that when they, you know, are working 18 hours a day and the other guy is shooting at them and they start exaggerating things a little, I just don’t think you should expect more of human beings than — and I think that they will tend — I think any one of the three candidates — will tend to behave quite well in the White House. They’ll succumb to all the things that presidents do in terms of having to — certain groups that helped them get there and all that sort of thing. But I think, on balance, they will end up doing what they think is best for the country, and I think they’re all smart people.

28. “There will be no gap after my death”

WARREN BUFFETT: Number 12?

AUDIENCE MEMBER: My name is John Ebert (PH). I’m from Bremerton, Washington. I’m very pleased to see that both you and Charlie look so healthy, and I’m also glad to know that your goal is to work to at least 102 before you retire. I think your secret must be the Cherry Coke and the See’s Candy by evidence of what you’re doing on the screen there. My question, obviously, deals with succession. At last year’s meeting, you spoke about your plan for your chief financial officer. Could you please update us on where you stand on succession?

WARREN BUFFETT: Yeah. And we’ve said, on the CEO front, we have three that any one of which could step in and do a better job than I do in many respects. And the board is unanimous, I believe, in terms of knowing which one it would be if it were tomorrow morning, but that might be different two or three years from now. I think in any event, when the time comes, they’ll want to pick somebody reasonably young, because I think, on balance, it’s good idea to have a long run at this job, and I think it aids in acquisition and being able to make promises to people about how their businesses will be treated and so on. In terms of the investment officer, the board has four names. We’ve discussed the four. Any one or all of the four would be good at doing my job, probably better in some ways, and — but they all have good jobs now. They’re happy where they are now. They would — I think any one of the four would be here tomorrow if I died tonight and they were offered the job by the board. They’re all reasonably young.

They’re all very well to do or rich, and compensation would not be a major factor with them. I think any of the four would take the job at less money than they’re making now, but there’s no reason for them to come now. I would still end up making the decisions, and they would probably chafe at the idea of not being able to make the decisions. I actually worked for Ben Graham for a few years. And I loved the man enormously. I learned an amount from him. I named my older son, middle name, is after him. But in the end, I wanted to make decisions, and I — if Ben Graham made them differently — you know, I actually prefer to make my own decisions. And anybody that manages money well is going to feel that way. So it’s just better in this case. It can happen tomorrow. It could happen five years from now. But whenever I’m not around to make the decisions, the board will decide whether to have one, two, three, or four of these people. They’ll decide — you know, they may decide to have four and divide it up four ways. They may decide to have only one.

They will probably be heavily influenced by how the incoming CEO feels about exactly how he wants to work with a group or with one. And they’ll come. So there will not — there will be no — there will be no gap after my death in terms of having somebody managing the money, and they’ll probably be a lot more energetic than I am now. And they’ll — they could very easily have a much better record. Some of them have a much better recent record than I do. Charlie?

CHARLIE MUNGER: Well, you know, we still have a rising young man here named Warren Buffett. And having — (Applause)

WARREN BUFFETT: That’s the advantage of working with a guy 84. You always look young. (Laughter)

CHARLIE MUNGER: And I think we want to encourage this rising young man to reach his full potential. (Laughter and applause)

WARREN BUFFETT: One thing I should point out, with our average age being 80, people talk about aging managements. We haven’t found a management that isn’t aging. If we ever find them, we want to start eating what they eat. And what I can point out about your management, since our average age is 80, we’re only aging at the age of 1 1/4 percent a year, and that is the lowest rate of aging that I know of in corporate America. I mean, some of these companies have 50-year-olds, and they’re aging at 2 percent a year, and just think how much riskier that is. (Laughter)

29. “Diversification is for the know-nothing investor”

WARREN BUFFETT: Let’s go to 13.

AUDIENCE MEMBER: I’m Isaac Dimitrovski (PH) from New York City. Mr. Buffett, it’s great to be here. I’ve read that there were several times in your investing career when you were confident enough in one idea to put a lot of your money into it — say, 25 percent or more. I believe a couple of those cases were American Express and the Washington Post in the ’70s. And I’ve heard you discuss your thinking on those. But could you talk about any of the other times you’ve been confident enough to make such a big investment and what your thinking was in those cases?

WARREN BUFFETT: Charlie and I have been confident enough — if we were only running our own net worth — I’m certain a very significant number of times, if you go over 50 years, there have been a lot of times when you would have put at least 75 percent of your net worth into an idea. Wouldn’t there, Charlie?

CHARLIE MUNGER: Well, but 75 percent of your worth outside Berkshire has never been a very significant amount.

WARREN BUFFETT: No. Well, I’m going back — let’s just assume it was. (Laughter) Let’s just assume you didn’t have Berkshire in the picture. There have been times — I mean, we’ve seen all kinds of ideas we would have put 75 percent of our net worth in.

CHARLIE MUNGER: Warren, there have been times in my life when I’ve had more than a hundred percent of my net worth invested in things.

WARREN BUFFETT: That’s because you had a friendly banker; I didn’t. (Laughter) That — there have been times — well, initially, I had 70 — several times I had 75 percent of my net worth in one situation. There are situations you will see over a long period of time. I mean, you will see things that it would be a mistake — if you’re working with smaller sums — it would be a mistake not to have half your net worth in. I mean, there — you really do, sometimes in securities, see things that are lead-pipe cinches. And you’re not going to see them often and they’re not going to be talking about them on television or anything of the sort, but there will be some extraordinary things happen in a lifetime where you can put 75 percent of your net worth or something like that in a given situation. The problem has been the guys that have put 500 percent of their net worth in. You know, I mean, if you look at — just take LTCM. Very smart guys. Very decent guys. Some friends of mine. High grade. Knew their business.

But they put, you know, maybe 25 times their net worth into things that were a cinch, if they hadn’t have gone in that heavily. I mean, they were in things that had to converge, but they didn’t get to play out the hand. But if they’d have had a hundred percent of their net worth in them, it would have worked out fine. If they would have had 200 percent of their net worth in it, it would have worked out fine. But they instead went to, you know, maybe 2500 percent or something like that. So there are stocks — I mean, actually, there’s quite a few people in this room that have close to a hundred percent of their net worth in Berkshire, and some of them have had it for 40 or more years. Berkshire was not in a cinch category. It was in the strong probability category, I think. But I saw things in 2002 in the junk bond field. I saw things in the equity markets.

If you could have bought Cap Cities with Tom Murphy running it in the early — in 1974, it was selling at a third or a fourth what the properties were worth and you had the best manager in the world running the place and you had a business that was pretty damn good even if the manager wasn’t. You could have put a hundred percent of your net worth in there and not worry. You could put a hundred percent of your net worth in Coca-Cola, earlier than when we bought it, but certainly around the time we bought it, and that would not have been a dangerous position. It would be far more dangerous to do a whole bunch of other things that brokers were recommending to people. Charlie, do you want to —?

CHARLIE MUNGER: Yeah. If you — students of America go to these elite business schools and law schools and they learn corporate finance the way it’s now taught and investment management the way it’s now taught. And some of these people write articles in the newspaper and other places and they say, “Well, the whole secret of investment is diversification.” That’s the mantra. They’ve got it exactly back-ass-ward. The whole secret of investment is to find places where it’s safe and wise to non-diversify. It’s just that simple. Diversification is for the know-nothing investor; it’s not for the professional.

WARREN BUFFETT: And there’s nothing wrong with the know-nothing investor practicing it. It’s exactly what they should practice. It’s exactly what a good professional investor should not practice. But that’s — you know, there’s no contradiction in that. It — a know-nothing investor will get decent results as long as they know they’re a knownothing investor, diversify as to time they purchase their equities, and as to the equities they purchase. That’s crazy for somebody that really knows what they’re doing. And you will find opportunities that, if you put 20 percent of your net worth in it, you’ll have wasted the opportunity of a lifetime, you know, in terms of not really loading up. And we’ve had the chance to do that, way, way in our past, when we were working with small sums of money. We’ll never get a chance to do that working with the kinds of money that Berkshire does. We try to load up on things.

And there will be markets when we get a chance to from time to time, but very seldom do we get to buy as much of any good idea as we would like to.

30. Parents Television Council and appropriate ads

WARREN BUFFETT: Go to number 1.

AUDIENCE MEMBER: Good morning, Mr. Chairman and Charlie. I’m Father Val Peter. For 25 years I was lucky to be head of Boys Town. Expanded across the whole country. Warren was very kind to me, very helpful, over long periods of time. What I represent today is Parents Television Council, where 1.2 million folks across the country, and our concern is to help keep toxicity off television programs — excessive violence, et cetera. And I was very surprised, being on a parents television council board, when I read a report — I hope it’s not true, but it might be — that says that of the best and most troublesome advertisers, Berkshire Hathaway, is near the bottom at 444 out of 452. I hope that’s not true. But my point is this: when I was head of Boys Town and somebody said something like that, I’d say, “Go find out. Correct it.” My question is would you be kind enough to say, “Go find out,” if it’s necessary, “Correct it.” Thank you.

WARREN BUFFETT: Yeah. I would say this: I don’t know where the rankings come from. I mean, I see the — certainly by far our biggest advertiser would be GEICO. We spend over $700 million a year on advertising. I see their ads all over the place, and, you know, I don’t regard them as offensive or inducing antisocial behavior or anything like that. But I would be glad for you to contact Tony Nicely because I can’t think of any other company at Berkshire that does, remotely, the amount of advertising. And Tony is an easy fellow — he’s here now, actually, but you could write him at GEICO or you could find him at the GEICO booth, probably, later in the day and just talk to him about that. I’d be glad to have you do that, Father Peter.

31. Diversification, IRAs, and brokerage accounts

WARREN BUFFETT: Number 2.

AUDIENCE MEMBER: Good morning Mr. Buffett, Mr. Munger. My name is Deb Caviello, (PH) and I’m from Windsor, New Jersey. I’m 45-years-old and have achieved financial independence in that I’m able to manage the money of my spouse and myself full time. And that goes to marrying well, part of that. I was —

WARREN BUFFETT: That can be a big part of it. (Laughter)

AUDIENCE MEMBER: Marrying well in the sense that I received the encouragement and the confidence to pursue that.

WARREN BUFFETT: That’s terrific.

AUDIENCE MEMBER: I was going to ask you a question more along the lines of diversification, but I think I will put it this way. I’ll skew it a little differently. Each of us has a traditional IRA, a Roth IRA, and together we have a brokerage account. Should the assets in those accounts be separated or better managed as a whole pile? In other words, have overlapping securities in each account or different types of securities relegated to a specific account?

WARREN BUFFETT: Yeah. Well, I would say your marriage sounds like it’s going to last, so I think you should think of yourself and your husband as a unit. And I would — you should — in my view, you should look at your overall financial condition and not worry about where the location of the assets will be. So if you have a net worth of X and you have 20 percent of it in a 401(k) and 30 percent outright and so on like that, just look at the whole picture and decide what mix of assets, what type of assets you want, and don’t treat them as being in separate pots. I mean, at Berkshire, you know, we own stocks in a whole bunch of different — our insurance companies own stocks in separate portfolios and we even have a portfolio in Cologne as mentioned earlier. I don’t even think about what entity anything is in. You know, it’s all working for Berkshire, and I think you should — the way to think about your situation is to think about it all working for your family.

Now, if you’re — you strike me as having a very solid marriage, and I think your husband would be crazy if he split with you. But the — if you’re just starting out, you may want to keep your money separate for a while until you see how it plays out, because a significant percentage do end up in divorce. Listen, I don’t get into marriage counseling very often. (Laughter) But I can feel the ground sort of disappearing between my feet here. But I will turn it over, therefore, to our marital expert, Charlie Munger. (Laughter)

CHARLIE MUNGER: Yeah. Occasionally, you’ll find an investment that is going to produce a huge amount of taxable income. It’s a junk bond paying a high yield that’s taxable or something. So some items are more suitable for those retirement accounts that get tax-deferral benefits. But apart from that, it’s all one pot. Sure.

32. Eventually power will have to come from the sun

WARREN BUFFETT: Number 3.

AUDIENCE MEMBER: Hi, Warren. I’m Doug Hicks (PH) from Akron, Ohio. And you hear on the news lately a lot of people say that oil will run out during this century. Considering the U.S. policy is to do nothing until the very last second, how do you think the end of oil will play out? For example, do you think that this would, unfortunately, result in World War III? Or do you think alternative energy will be available, the day that oil runs out, to take its place? And maybe, do you think these oil companies’ value will go to zero when oil runs out?

WARREN BUFFETT: Yeah. Oil won’t run out. It doesn’t work that way. What oil will do at some point — who knows when — people predict a lot of different things — oil at some point, daily productive capacity throughout the world will first level off and then start declining very gradually. The nature of oil extraction is such that wells don’t — with rare exceptions — they don’t go to a given point producing a hundred barrels a day and then all of a sudden quit or anything like that. So you run into this depletion aspect and get into decline curves and that sort of thing. So we won’t — we’re producing in the world, 86 or 87 million barrels a day of oil, which is more than we’ve ever produced before. We are closer — by at least my calculations — we are very much closer to producing almost as much as our productive ability is in the world, with fields in their current stage of development, than we’ve ever been. I mean, our surplus capacity, I think, is less than, well, any time I can remember. And it’s quite a bit less than most periods.

So we don’t have the ability to crank up, in any short period of time, the 86 or 7 to a hundred million barrels a day. But whatever that peak will be, and whether we hit it five years from now or 50 years from now, and then it will just gradually taper down, and the world will adjust to it, and hopefully we’ll be thinking about it, you know, well before it happens, and various adjustments will be made in the world that will cause the demand to somewhat taper down as the available supply. But we will be producing oil far beyond this century. It’s just — the question is whether we’re producing 50 million barrels a day, or 75 million, or 25 million barrels a day. I don’t know the answer to that. There’s a lot of oil in place in the world. We’ve messed up the recovery of a lot of the oil. I mean, we never recovered the, you know, the total potential of fields. And some fields we’ve mis-engineered in ways so that we will recover a very small percentage.

Now, maybe there will be better engineering, tertiary recovery, and that sort of thing in the future. It’s nothing like an on and off switch, though, in terms of the world producing oil or adjusting to reduced capacity or anything like that. You may still have enormous political considerations to — access to the available oil — because it’s going to be so darn important to our society for so long. There’s nothing we can do, in any short period of time, that will wean the world off of oil. You know, that is a fact of life. Charlie?

CHARLIE MUNGER: Well, if we get another 200 years of economic growth pretty well disbursed over the world, while the population of the world also goes up, all of the oil, coal, natural gas, and uranium reserves of the world are like nothing. So eventually, of course, you have to use the sun. There is no other alternative. And I think we can confidently predict that there will be some pain in this process of adjusting to a different world. Personally, I think it’s extremely stupid to use up the hydrocarbon reserves of the world as fast as we are. I don’t think we’ve got any good substitutes for those things as chemical feed stocks, and I think it’s perfectly crazy to use up something so precious for which you have no alternative that’s sure to be available. And if you look at it backwards, what should we have done? Hell, we should have bought all the oil in the ’30s in the Middle East and take it over here by tankers and put it in our own ground. I mean, it’s obvious to see what should have been done in the past.

Even though that’s obvious, are we doing the equivalent of that now? And the answer is, basically, no. So I think the governmental policy tends to be way behind in terms of rationality. And I think we’ll just have to soldier through. But eventually the — if we’re going to have a prosperous civilization — we have no other alternative than the sun.

WARREN BUFFETT: What’s your over-under figure for 25 years from now, world production oil per day?

CHARLIE MUNGER: Down.

WARREN BUFFETT: Yeah. (Laughter) That’s not an insignificant prediction. I mean, it — believe me. If oil production is down 25 years from now, it will be a different world. I mean, you — China’s going to sell over 10 million cars this year. I mean, the demand is going to keep — even at these prices — it’s hard for me to imagine demand falling off a lot. So if production falls off, you’ll have some interesting consequences.

33. Higher taxes for the superrich under Pres. Buffett

WARREN BUFFETT: Number 4.

AUDIENCE MEMBER: Mr. Buffett and Mr. Munger, my name is Guy Pope, and I’m from Portland, Oregon. I enjoyed the cartoon this morning, and I’d like to expand on that. I, too, like the idea of both of you serving as a single term as the President of the United States. During — hypothetically, let’s say, Mr. Buffett, you served the first term; Mr. Munger, you served a second term.

WARREN BUFFETT: I think the other way around is better, but go ahead. (Laughter)

AUDIENCE MEMBER: Each of you please name three difficult policy decisions you would implement during your term to better the country.

WARREN BUFFETT: Well, Charlie is going to serve the first term, so I’m going to let him name his three.

CHARLIE MUNGER: I think that one takes us so far afield that I think it’s asking too much. Three perfect solutions to the major problem of mankind from each of us in a few minutes? We’ve just barely managed to stagger through life as well as we have, and I don’t think we’re quite up to it. (Laughter)

WARREN BUFFETT: We’d probably have a massive federal program for retirement homes, actually. (Laughter) I would probably do something about the tax system that would change things so that the superrich paid a little more and the middle class paid a little less, but — (Applause.)

WARREN BUFFETT: That might be why you’d prefer to have Charlie serve first.

34. Munger: Ethanol is “monstrously dumb”

WARREN BUFFETT: Number 5.

AUDIENCE MEMBER: Hi. I’m Ryan Johnson (PH) from Arizona, and I wanted to ask what you think about the food shortages in the world and what trends you see in the next decade or two?

WARREN BUFFETT: Well, again, I’m no expert on that. Charlie?

CHARLIE MUNGER: Well, I said last year that I thought that the policy of turning American corn into motor fuel was one of the dumbest ideas, in terms of the future of the world — (applause) — that I’d ever seen. I came out here with the head of an academic institution, and he called the idea stunningly stupid. Now, I’m here in Nebraska where I like Nebraskans to prosper. But this idea was so monstrously dumb that I think it’s probably on its way out.

35. Amateurs should stick with low-cost index funds

WARREN BUFFETT: We’ve now — oh, no. We’ve got time for a couple more. Let’s go to number 6.

AUDIENCE MEMBER: Hi. My name is Timothy Ferriss. I am a guest lecturer at Princeton University twice a year. And I’d like to touch on an earlier question about investing with small sums of money. I’d like to ask both of you, if you were 30-years-old again and had your first million in the bank, how would you invest it, assuming you’re not a full-time investor, you have another full-time job, you can cover your expenses with other savings for about 18 months, no dependents, and it would be really helpful for my students, for myself and others here, if you could be as specific as possible about asset classes, percentages, whatever you’re willing to offer. (Crowd noises)

WARREN BUFFETT: Well, I’ll be very simple: I — under the conditions you name, I’d probably have it all in a very low-cost index fund, and it would probably be — you know might be Vanguard — somebody I knew was reliable, somebody where the cost was low. And because you postulated that you’re not going to become a professional investor, I would recognize the fact that I’m an amateur investor, and I would feel that a — unless bought during a strong bull market, which this hasn’t been — I would feel that that was going to outperform, to a degree, bonds, under current conditions over a long period of time, and then I’d forget it and go back to work. Charlie?

CHARLIE MUNGER: Yeah. It’s in the nature of things that you aren’t going to have a whole lot of screamingly successful professional investors. You’ve got a great horde of professionals taking croupiers profits out of the system, most of them by pretending to be professional investors, and that is in the nature of things, too. But if you don’t have any rational prospects of being a very skilled professional investor, of course you should compromise on some simple thing like an index fund.

WARREN BUFFETT: Yeah. And that — you will not get that advice from anybody because nobody gets paid to give you that advice. So you will have all kinds of people telling you how much better they can do for you than that, and how if you just give them a wrap fee, or give them commissions, or whatever it may be, that they will do better, but they won’t do better. On average, you know, if a thousand other people like you do the same thing, that group of a thousand will do worse if they listen to the people that make pitches at them. And in the end, why should you expect — I mean, you’ve got a very perfectly decent return over a 30- or 40-year period by doing what I suggest. And why should you expect more than that when you don’t bring anything to the party? The salesman will tell you that you’ll get it, but you won’t.

CHARLIE MUNGER: I would give you another word of warning: do not judge stockbrokers generally by the ones you meet at this meeting. We attract some of the most honorable, intelligent stockbrokers in the world. They are not representative of the class.

WARREN BUFFETT: (Laughs) The politician in him just came out

36. No “extreme frugality” but don’t spend more than you make

WARREN BUFFETT: OK. We’ll do one more, and then we’ll break for lunch. Number 7.

AUDIENCE MEMBER: Good morning. My name is Tim Fam (PH). I’m from Austin, Texas. For my children, I would like to hear from both of you as far as the temptation to keeping up with the Joneses. And can you give them advice that they can live by with respect to frugality, debt, and work ethic?

WARREN BUFFETT: Yeah. Just tell them to keep up with the Buffetts. (Laughter) Well, Charlie and I have always been big fans of living within your income, and if you do that, you’ll have a whole lot more income later on. And, you know, it — I think they will, to a considerable extent, not a perfect extent, they will follow the example of their parents. I mean, if their parents are coveting, you know, every possession of their neighbor, you know, or trying to figure out ways to increase their cost of living without necessarily their standard of living, the kids are likely to pick up on it. But now you can get the reverse effect. If you get too tough with them, they go crazy later on. (Laughs) But the — it’s — people make that election. Incidentally, there are people — there are plenty of people that I don’t advise to save.

I mean, the real — if you’re struggling along and making a reasonable income and you have a job with a 401(k) being put aside for you, and you have Social Security, who’s to say whether it’s better to defer a dollar of expenditure on your family on a trip to Disneyland or something that they’ll get enormous enjoyment out of so that when you’re 75 you can have a, you know, 30-foot boat instead of a 20-foot boat? I mean, there are choices and there are advantages to spending money in various forms for your family when it’s young, and giving them various forms of enjoyment or education or whatever it may be. So I don’t — I don’t advocate — I may practice — but I don’t advocate extreme frugality. The — and I don’t say that it’s always better to be saving 10 percent of your income instead of 5 percent of your income. I think it’s crazy to be spending 105 percent of your income, and I think that leads to all kinds of problems, and I get letters from people every day that have experienced those problems.

But, you know, in the end you want to have an internal score card. I mean, you are not a better person or a worse person because you live a different kind of life than your neighbor. Live a life that, you know, is true to yourself. Charlie?

CHARLIE MUNGER: Yeah. It’s obviously the best method to train your children to provide the proper example. (A person in the audience is shouting)

WARREN BUFFETT: I think we’re hearing a child that didn’t get that advice. (Laughter)

CHARLIE MUNGER: But of course, even if you do provide the proper example, it’s likely not to work —

WARREN BUFFETT: It’s noon.

CHARLIE MUNGER: — some of the time anyway.

WARREN BUFFETT: It’s noon now. We’ll take about a 30 to 40-minute break. We’ll come back. Some of those who are in the other room — we always have some openings here after lunch so you might be able to move into the main room. We’ll reconvene, we’ll say, at 12:45. We’ll go to 3 o’clock.

Afternoon Session

1. No more Klamath Dam questions

WARREN BUFFETT: OK. We’re going to go back to work here. We broke off at area seven last time. I have asked — just so everybody’s aware of it — we’ve had three questions relating to the Klamath situation, and I think that’s more than proportional to the interest of the crowd. (Applause) So we’ll skip any more like that. I think the position is known.

2. “Too big to fail” banks can’t have “too much risk to manage”

WARREN BUFFETT: And we’ll go onto number 8.

AUDIENCE MEMBER: My name is Ola Larson (PH). I live in Salt Lake City. And I think — on Lou Rukeyser, Wall Street Week, 1981 or something. So you must really have impressed me, Warren. What I’d like to ask you is that looking at the future, have the business practices of the investment banks become so complex that it is not possible for the head of the investment bank to be aware of the exposures to financial risks day-to-day or week-to-week?

WARREN BUFFETT: Yeah. That’s an exceptionally good question, and I think the answer, probably, is yes, at least in some places, although there’s a few investment bank heads I’ve got enormous respect for their ability to sort of get their minds around risk. But I decided, for example, when we bought Gen Re, it had about 23,000 derivative contracts, and I think I could have spent full time on that and not really been able to get my mind around how much risk we could — we were running — under some fairly extreme conditions that I did not think were impossible, but that the people who were running the operation might have thought were impossible, or that might not have cared about it that much because their own incentive compensation was such that if they made a lot of money one year on something, it would work 99 years out of a hundred, they would feel the chances of something going wrong big were very slim. But I don’t want to have it slim. I want to have it none. So I regard myself as the Chief Risk Officer at Berkshire.

If something goes wrong at Berkshire because of — in terms of risk — of the way we run the place, there’s no way I can assign that to a risk committee or have some mathematicians come in and make a bunch of calculations and tell me I’m only running a risk that will happen once in the history of the universe or something of the sort. I think the big investment banks, a number of them — and big commercial banks — I think they’re almost too big to manage effectively from a risk standpoint in the way they’ve elected to conduct their business. And it’s going to work most of the time. So you don’t see the risk in a way that — I mean, you don’t — if you have a 1 in 50-year risk that a place will go broke, it may not be in the interest of a 62-year-old executive that’s going to retire at 65 to worry too much about that. I worry about everything at Berkshire. So I would say they’re too — they’re very hard to manage, very hard to have your mind around.

I mean, clearly, you’ve seen cases in the last year where very big institutions, if the CEO knew what was going on, he certainly hasn’t admitted it subsequent to what’s happened. It’s embarrassing either way, but it’s less embarrassing to say I didn’t know what was going on than to acknowledge that you knew these kind of activities were going on and you let them go on. It’s — I’ve been asked for advice on regulation sometimes, and we’ve seen an extraordinary example, which somehow the press really hasn’t picked up on much. But you had an organization called OFHEO whose sole job was to supervise two big companies, and these big companies were Fannie Mae and Freddie Mac. And they had a large element of public purpose in them, and they were chartered by the federal government, and they had — their activities had overtones for the whole mortgage and securities markets.

So Congress said, “If we’re going to give you all this ‘too big to fail’-type protection, in terms of the federal government stepping in and giving you special privileges, we want to keep an eye on you.” So they formed OFHEO and they had 200 people going to work, I presume at 9 o’clock every morning, and going home at 5, and their sole job was to see what these two places were doing. And they turned out to be two of the biggest accounting misrepresentations in the history of the world. So they were two for two with the only things they had to examine. And I fear that if you tried to do the same thing with the biggest commercial banks or the biggest investment banks, I’m not sure you can keep track of it. What you need is somebody at the top whose DNA is very, very much programmed against risk. And he is going to have to resist the entreaties of those who work beneath him who say everybody else is doing it, and if they can do it over there and make all this money doing it, why can’t we be doing it here? And that’s not easy to do.

When you’ve got a bunch of high-powered people who are used to making in seven figures every year, and they want to do things and they say, “If you don’t do them here, we’re going to go elsewhere,” it’s a very tough system to be. So I would say that, in many ways, there are firms that, in terms of risk, are simply — they are conducting themselves in a way that they’re too big to manage. And if at the same time the government says they’re too big to fail, that has some very interesting policy implications. Charlie?

CHARLIE MUNGER: Well, I would argue that you say that very well. It does have interesting policy implications. It’s crazy to have people get so big and so important that you can’t allow them to fail, and allow them to be run with as much knavery and stupidity as permeated the major investment banks. It’s not that Berkshire hasn’t had wonderful service from investment banking all these years, because we have. It’s just that, as an industry, this crazy culture of greed and overreaching and overconfidence in trading algorithms and so on creeps in. I would argue it’s quite counterproductive for the country, and it ought to be reigned way back. These institutions are too big to fail, and it was demented to allow derivative trading to end up the way it’s ended up and with the current risks that are embedded in the present system. And it’s amazing how few people spoke against it as it was happening. There was just so much easy money to be reported. A lot of the money that was reported as being earned wasn’t really being earned.

It was in that wonderful category of assets that I call “good until reached for.” They sit there on the balance sheet, and when you reach for it, it just fades away like — (laughter)

WARREN BUFFETT: He’s not kidding.

CHARLIE MUNGER: — mist.

WARREN BUFFETT: He’s not kidding.

CHARLIE MUNGER: We had 400 million of that “good until reached for” assets we got with General Re.

WARREN BUFFETT: And they were behaving honorably.

CHARLIE MUNGER: Yes. But at any rate, people pushed it way too far. In the drug business, they say, “Prove that this works” before they certify the drug. On Wall Street, they start believing in the tooth fairy, and if one guy is reporting a lot of money, why, everybody else is asking, “Why aren’t we betting on the tooth fairy?” It’s a crazy culture, and to some extent it’s an evil culture, and it needs a huge reigning in. And the accounting profession utterly failed us. The worst behaving were the people who set the accounting practice standards. And they’re very bureaucratic and take forever, and they don’t want to do anything real difficult that displeases people. This is not a combination of wonderful qualities when your job is to set accounting standards, which ought to be dealt with sort of like engineering standards. And they don’t even have the right approach. So there’s a lot wrong.

WARREN BUFFETT: When Charlie and I first got to Salomon, we noticed that they were trading with Marc Rich, who had fled the country. And we suggest — well, we told them — we wanted to quit trading with Marc. And they said, well, they were making money doing it one way or another, and they said, what the hell did we know about crude oil trading, and they wanted to keep trading with him. And only by just total directive could we stop our own employees from trading with Marc Rich. Now, if you can’t stop your people trading with Marc Rich, you know, when you’re focusing on it, just imagine what goes on, you know, in those trading rooms elsewhere. It’s — if Bear Stearns — I think the Fed did the right thing by stepping in on Bear Stearns. If Bear Stearns had failed on Sunday night — and it would have — they would have walked over to a federal judge and handed him a bankruptcy petition, I guess, a little after 6 o’clock Midwest time, because that’s when Tokyo opened.

If they had failed, the next day, as I understand it, they had about 14 1/2 trillion — which isn’t as bad as it sounds — but 14 1/2 trillion of derivative contracts. Now, the parties that had those contracts that had a claim against Bear Stearns would have been required, I think, almost by the contracts they signed, but they would have been required to undo those contracts very promptly to establish the damages they would have against the bankrupt estate. Just imagine thousands of counterparties around the world, you know, trying to undo contracts, everybody knowing they had to undo contracts in a very, very short period of time. The 400 million we tried to reach for and didn’t find — we had the luxury of spending about four or five years unwinding those contracts. These people would have had four or five hours to do the same thing with everybody else doing it simultaneously. It would have been a spectacle that would have been of, I think, of unprecedented proportions, and, of course, it would have resulted, in my view, of another investment bank or two going down, you know, within a matter of days. Because nobody has to lend you money.

In fact, that was one of the interesting things that was said at the testimony when they called them down to the Senate Finance Committee. They — I think two of the witnesses said, we didn’t understand — we understood we couldn’t borrow money unsecured, if people started looking at us with askance, but they said, we didn’t dream we couldn’t borrow money secured. Well, we’d found that out at Salomon that we were having money borrowing money secured 17 years earlier. When the world doesn’t want to lend you money, ten basis points doesn’t do much, you know, or 20 basis points, or 50 basis points much, or a bigger haircut on collateral. If they (don’t) want to lend you money, they don’t want to lend you money. And if your dependent on borrowed money every day, you have to wake up in the morning hoping the world thinks well of you. And there was a period there a few months ago when I think every investment bank in the United States was plenty worried about whether people were going to think well of them the next morning.

3. Why we don’t do ‘due diligence’ for even the biggest deals

WARREN BUFFETT: Well, let’s go on to number 9.

AUDIENCE MEMBER: Harry Beguy (PH), San Francisco. Mr. Buffett, I was reading recently in Fortune magazine that when you invested $500 million in PetroChina back in 2001 or 2002, all you did was read the annual report. Now, I was thinking that most professional investors with the kind of resources that you have would have liked to have done a lot more research and talked to management, maybe regulators, et cetera, et cetera. The question I have is, how — what is it that you look for when you’re reading an annual report like that? How is it that you were able to, and did, make an investment purely on the back of reading that report?

WARREN BUFFETT: Yeah. Well, it was in 2002 and 2003, and the report came out in the spring, and I read it. And that’s the only thing I ever did. I never contacted any management. I never got a brokerage report. I never asked for anybody’s opinion. But what I did do is I came to the conclusion that the company — and it’s not hard to understand crude oil production and refining and marketing and the chemical operation they have. I mean, you can do the same thing with Exxon or BP or any of them, and I do that with all — I look at them. And I came to the conclusion it was worth a hundred billion, and then I checked the price and it was selling for 35 billion, roughly. What’s the sense of talking to management? I mean, basically, if you talk to management of almost every company, they’ll say they think their stock is a wonderful buy, and they’ll give you all the good stuff and skip over things that — it just doesn’t make any difference.

Now, if I thought the company was worth 40 billion and had been selling for 35 billion, then at that point you have to start trying to refine your analysis more. But there’s no reason to refine your analysis. I mean, I didn’t need to know whether it was worth 97 billion or 103 billion if I was buying it at 35 billion. So any further refining of analysis would be a waste of time when what I should be doing is buying the stock. So we really like things that you don’t have to carry out to three decimal places, you know. If you have to carry it out to three decimal places, it’s not a good idea. And, you know, it — with something like PetroChina — it’s like if somebody walked in the door here and they weighed somewhere between 300 and 350 pounds. I might not know how much they weigh, but I would know they were fat. (Laughter) That’s all I’m looking for, is something that’s financially fat. And whether PetroChina weighed 95 billion dollars or 105 billion didn’t make much difference. It was selling for 35 billion.

If it had been selling for 90, it would have made a difference. So if you can’t make a decision on something like PetroChina off the figures, forget about going further, and that’s basically what we did. It’s a straightforward report, just like reading another — just like reading Chevron’s or ConocoPhillips or something like that. Just as informative. And you weren’t going to learn more, you know, by going out and deciding whether you thought — they’ve got one huge field in China where the life of it was 13 years or 14 years or something of the sort. They should hit you between the eyes. Charlie?

CHARLIE MUNGER: Yeah. I would argue that we have lower due diligence expenses than anybody else in America — (laughter) — and that we have had less trouble because we had less expense. I know of an investment operation in America that pays over $200 billion a year that —

WARREN BUFFETT: Two-hundred million.

CHARLIE MUNGER: 200.

WARREN BUFFETT: Million.

CHARLIE MUNGER: Yes. 200 million. Pardon me.

WARREN BUFFETT: Uh-huh.

CHARLIE MUNGER: — every year to its accountants, a lot to help them with due diligence. And I think our operation is safer because we think like engineers. We want these margins of reliability. And they’re trying to do something really difficult, which is to have fine-grain judgments in very complex areas, and rely on other people to do it who are getting paid fees. It’s a very dicey process to do that. I think it’s much safer to do our way.

WARREN BUFFETT: If you think the auditors know more about making an acquisition than you do, you ought to take up auditing and let them run the business, as far as we are concerned. We are not — I mean, when we get a call on something like the Mars-Wrigley situation, if we don’t know enough about Mars and Wrigley by this point so that we have to go out — I still like to go out, of course, and sample all the bars. So we have a 15 — I mean, I feel I owe that to the Berkshire shareholders (Laughter) But I’m not going to look at their labor contracts or their leases or anything like that. If the value of Wrigley depends on a specific lease someplace or a specific commitment to this or that, you know, or a given environmental problem, forget it, you know. The — there are these overriding considerations that are enormously important, and then there’s a whole lot of trivia that doesn’t mean anything. We have never made a — we’ve made plenty of big investment — I’ve made plenty of big investment mistakes.

I’ve never made one, in my view, that would have been avoided by conventional due diligence. And we would have spent a lot of money, and we would have wasted a lot of time and, in some cases, we would have missed deals, simply because we wouldn’t have committed fast enough. We have a significant advantage, and it gets bigger as we get bigger, because, in terms of big deals, people rely more and more often on process, in that when people want to get a deal done, they want to know it’s going to be done, they will come to us. I mean, the Mars people wanted to deal — in terms of this financing aspect of the Wrigley situation — they only wanted to deal with Berkshire because they knew we didn’t have any lawyers involved. I’ll admit to this group we didn’t even have any directors involved. We just — you know, we got a call, it made sense, and we said yes. And when we say yes, we don’t say yes with a material adverse change clause. We don’t say yes, if financing is available. We just say yes.

So I can tell people when we make a deal that, if we’re going to have 6 1/2 billion available, it’s going to be available, you know, whether there’s a nuclear bomb goes off in New York City, or whether there’s a flu epidemic, or whether Ben Bernanke runs off to South America with Paris Hilton. (Laughter) The check is going to clear. And if you’re making a deal, you know, the guy that wants the 6 1/2 billion, that assurance is worth something. And you really can’t get anyplace — they say, “Well, I’ll do it, but I’ve got to have a due diligence team check this out and do all of that.” So it’s a real advantage to us, and I don’t think there’s any disadvantage to us.

4. Buffett on religion: “I’m a true agnostic”

WARREN BUFFETT: Number 10.

AUDIENCE MEMBER: Hi, Mr. Buffett. My name is Matthew Millard (PH). I’m from Norman, Oklahoma, and —

WARREN BUFFETT: We’ll forgive that as Nebraskans. (Laughter)

AUDIENCE MEMBER: That’s OK. Thank you. I’ve been a long-time Berkshire shareholder since I was 16. Really like the company. Really like your investment style, buy and hold forever, kind of beyond the grave. But my question actually had to do with, do you know and believe in Jesus Christ and have a personal relationship with him.

WARREN BUFFETT: No. I’m an agnostic. And I grew up in a religious household. And if you’d have asked that question of my mother and father, you’d have gotten a different answer. And I’m a true agnostic. I’m not closer to either a theist or an atheist. I simply don’t know, and maybe someday I’ll know and maybe someday I won’t, but that’s the nature of being an agnostic. Charlie?

CHARLIE MUNGER: I don’t want to talk about my religion.

WARREN BUFFETT: OK. Well — (Applause.)

WARREN BUFFETT: Being an agnostic, I don’t have to talk about religion. It’s very simple. (Laughter) I don’t — obviously I have no opinion on anybody else’s religion because that’s the nature of being an agnostic. I wish everybody well on their own.

5. Berkshire takeover after Buffett dies is “very unlikely”

WARREN BUFFETT: Number 11.

AUDIENCE MEMBER: Hello. Good afternoon, Warren and Charlie. I want to thank you for hosting this annual meeting. My name is James (inaudible) from East Brunswick, New Jersey. I don’t want to sound morbid, but my question is, once you two are gone and Warren’s stock is placed in trust and slowly forced to be sold over the years, what safeguards are in place to prevent a hedge fund or LBO shops from joining together and acquiring Berkshire Hathaway, and putting in play and breaking up this wonderful company and endangering the culture of this company?

WARREN BUFFETT: Well, my stock would be sold over about a 12-year period after my death. During the time of settling the estate, it gets disposed of in the same manner as presently, and then it gets on a time clock. So that takes a lot of time. I may live a little longer, even, than now, but even if that started now, you would be dealing, I hope, with a company that had a market value much larger than even we presently have, and you’d still have large blocks of stocks held by institutions or people that certainly had a similar philosophy. There’s no guarantee that if somebody wanted to try a 6- or $700 billion takeover — and it might be, you know, a lot larger than that if you go out a ways — that it can’t be done. But I think it would be about as unlikely to happen in the case of Berkshire as any company I can think of in the world. It can’t happen at all, in effect, until sometime after I die. There will be a lot of votes concentrated until that period.

And like Charlie says, I’ve told — there’s this period after I die before this 10-year distribution period kicks in — so I’ve told my lawyer to make sure that my estate lasts for quite a while. And he says that’s like telling your teenage son to have a normal sex life, when you tell a lawyer that. But it will be a long time. And like I say, if we do anything in the way of decent rates of compounding, you really are talking, you know, one of the very largest companies in the United States. And I don’t think anybody’s going — I don’t think there’s going to be an LBO of General Electric or Exxon, and I think it would be equally difficult with Berkshire. There’s no 100 percent guarantee, however. Charlie?

CHARLIE MUNGER: Yeah. And, besides, Warren doesn’t plan to leave very early. I’ve heard him say several times when people ask him what he wants said at his funeral. And he always gives the same answer. He says he wants people to say, “That’s the oldest-looking corpse I ever saw.” (Laughter)

WARREN BUFFETT: And I’m unlikely to change my views on that subject. (Laughs) But thanks for asking. (Laughs)

6. It’s hard to challenge a well-established, popular brand

WARREN BUFFETT: Number 12?

AUDIENCE MEMBER: Hello. My name is Harold Yulean (PH). I’m from Chicago, Illinois. I’d like you to describe the economic characteristics of the Kraft Corporation, why you feel this is a good business.

WARREN BUFFETT: Well, I would say most of the big food companies are good businesses in that they earn good returns on tangible assets. And I don’t want to get into — particularly into specifics on Kraft — but if you own important, branded products in this country, whether it’s Wrigley’s or Mars or Coca-Cola, or a number of the Kraft brands, or See’s Candy, you have good assets. It’s not easy to take on those products. Just imagine, you know, taking on — Coca-Cola will sell a billion and a half eight-ounce servings of its product around the world today. There’s something in everybody person’s mind virtually in the globe about Coca-Cola. It’s a product of — since 1886 has been associated with happiness and good value in terms of refreshment and all that. It’s just about impossible, you know, to, in my mind, anyway, to take on a product like that. It’s clearly satisfies people in a huge way, you know, everywhere on the globe.

And, you know, it may not be the same — Kraft, for example, has Kool-Aid in the powdered soft drink business. You know, I don’t think I’d want to take on Kool-Aid. I’d rather have Coca-Cola. But it’s a tough product. And to get implanted — just think of — to get implanted in people’s mind RC Cola around the world. And RC Cola has been around a long, long time. You know, it isn’t going to go anyplace. I mean, that is very, very difficult. And actually, Richard Branson came over to this country — you know, they say that a brand is a promise. I mean, there’s a promise involved in picking up a Milky Way, or picking up a CocaCola, as to what it’s going to deliver to you. Richard Branson came over seven or eight years ago, 10 years ago, you know, a fellow with a famous airline and all of that, and he came out with something called Virgin Cola. And I thought that was kind of an unusual promise to have in a product.

(Laughter) Never could quite figure that one out, what the promise was. But whatever it was, it didn’t work. And there have been — I don’t know how many — Don Keough would know — but there have been hundreds of colas over the years. But in the end, who is going to, you know, buy some substitute cola for a penny a can less, or two cents a can less, than Coca-Cola, or the same thing with See’s Candy, or the same thing with Kool-Aid, or whatever it may be. So we feel pretty good about branded products when they’re runaway leaders in their field. And there’s nothing unusual about Kraft in their position versus Kellogg or some other people like that. So there’s — the specifics of which one we buy may depend a little bit how we feel about the price. It certainly will make a difference how we feel about the price, the management, and some other factors. But if you buy in with good branded products and you don’t pay too much, you’re probably going to do OK.

On the other hand, you’re not going to get super rich because the attributes that I’ve just laid out are pretty well recognized. Charlie?

CHARLIE MUNGER: I’ve got nothing to add.

WARREN BUFFETT: OK.

7. Avoid low-probability problems that could destroy the company

WARREN BUFFETT: I don’t — do we need to go to the other room or not? Well, let’s just go to number 1. If I’m skipping the other room and there are still people in there, somebody can let me know, and we’ll go back for them. Number 1.

AUDIENCE MEMBER: Hello, Mr. Buffett, Mr. Munger. My name is Kevin Truitt (PH) from Chicago, Illinois. My question is this: you have identified four investment professionals who will at some point in time be running the portfolio for Berkshire Hathaway. What was the criteria that you used to select the four people and what will be the criteria for evaluating them going forward?

WARREN BUFFETT: Yeah. The criteria for selecting, I think, we laid out pretty well in the 2006 annual report. We obviously look for people that have had pretty good records, but that criteria alone is nowhere near sufficient to come up with the candidates we want. I mean, we care enormously about human qualities, and we think we can make that judgment in some cases, and in some cases we can’t. I mean — and it’s no negative vote on people we skipped over. We just decided we didn’t know whether they would be the right kind of person. We made an affirmative judgment on four, as to both their ability and their integrity. And I would like to — there was one other item in here, I believe, which I think achieved a little added relevance in the last year. I said, “We therefore need someone genetically programmed to recognize and avoid serious risks,” and then I put in italics, “including those never before experienced.” And then I said, “Certain perils that lurk in investment strategies cannot be spotted by one of the models — by use of the models — commonly employed today by financial institutions.”

Well, I think that proved to be somewhat prophetic of what happened last year. All of these places had models. I mean, the major banks, the major investment banks. They would meet weekly at a risk committee, probably, and go over their models, and all of the statistics would be printed in nice columns and everything. And they didn’t have the faintest idea what risk they were involved. You really need, in the investment world, someone very solid, someone you trust, reasonable analytical skills. But you also need someone that actually can contemplate problems that haven’t popped up yet but which are starting to become possibilities, in terms of new financial instruments or new behaviors in markets and that sort of thing. And that’s a rare quality. I mean, that inability to envision something that doesn’t show up in your past model, you know, can be fatal. And Charlie and I spend a lot of time thinking about things that could hit us out of the blue that other people don’t include in their thinking. And we may miss some opportunities because of that, but we feel it’s essential when managing other people’s money or, for that matter, managing our own money.

So I would say that you might go back and read the 2006 annual report again, but those are the criteria we’re looking for and we have identified as being met by the four people we’re thinking about. Charlie?

CHARLIE MUNGER: Yeah. You can see how risk averse Berkshire is. In the first place, we try and behave in a way so that no rational person is going to worry about our credit. And after we’ve done that, and done it for many years, we also behave in a way that, if the world suddenly didn’t like our credit, we wouldn’t even notice it for months, because we have such liquidity and are so unlikely to be — unable to be — pressured by anybody. That double layering of protection against risk is like breathing around Berkshire. It’s just part of the culture. And the alternative culture is just the opposite. You call a man the Chief Risk Officer, but often he is functioning as a guy that makes you feel good while you do dumb things. (Laughter) So he’s like the Delphic oracle that convinced the Persian king to attack somebody or other. I mean, it’s — he’s just a dumb soothsayer. And how can a guy be dumb when he’s got a Ph.D. and he can do all this advanced math?

WARREN BUFFETT: Easy.

CHARLIE MUNGER: You can — (laughter) — but you can. It’s very — all you’ve got to do is crave system and computation so much that you torture reality into fitting some model — mathematical model — which really doesn’t match, particularly, under extreme conditions. And then, because of this work that you’re putting into everything and these computations about daily trading, risk, and so forth, you feel confident that you’ve clobbered the risk, but you haven’t. You’re just clobbered up your own head. (Laughter)

WARREN BUFFETT: Yeah. We really want to run Berkshire, you know — (Applause.)

WARREN BUFFETT: I’ll even applaud that one. (Laughs) We really want to run Berkshire so that if the world isn’t working tomorrow the way it’s working today and it’s working in a way nobody expected, that we don’t have a problem. We do not want to be dependent on anybody or anything else. And yet we want to keep doing things. So, we’ve found a way to do it — we think we found a way — to do that. It may give up some of the — well, obviously gives up earning higher returns 99 percent of the time, and maybe 99.9 percent of the time. Obviously, we could have run Berkshire with more leverage over the years than we have. But we wouldn’t have slept as well, and we wouldn’t feel comfortable — we’d have a lot of people in this room that have almost all their net worth in Berkshire, including me — and we wouldn’t feel comfortable running a business that way. Why do it?

I mean, it doesn’t — it just doesn’t make any sense to us to be exposed to ruin and disgrace and embarrassment and — for something that’s not that meaningful. If we can earn a decent return on capital, you know, what’s an extra percentage point? It just isn’t that important. So we will always try to behave in a way that, A, is not dependent on anybody else evaluating the risk except for us. It cannot be farmed out. And you’ve seen what happened to some institutions where the management thought they were farming it out. And, you know, if that means a reasonable return instead of a slightly unreasonable return, we just accept it.

8. “If we can’t make a decision in five minutes, we can’t make it in five months”

WARREN BUFFETT: Number 2. (Applause)

AUDIENCE MEMBER: Hello, Mr. Buffett. Hello, Mr. Munger. My name is (inaudible) (PH), and I’m from Munich, Germany. I would like to get back to your point that, as a professional investor, one should be able to act quickly and decisively. That means being able to know what the intrinsic value is and to act within a day or within an hour if the market offers an opportunity. My question is, how large is the universe of companies which you have in your head whose intrinsic value you know, where you would be able to act within a day or two if the market offered an attractive price to you? And, secondly, how come you suddenly invest in southern Korea or China?

WARREN BUFFETT: Yeah. We can act — our immediate decision is whether we can figure the — what’s being offered out to us or not. I mean, there’s a go/no-go signal. And Charlie and I are often thought to be rude when we think we’re just being polite and not wasting the other person’s time. So as they start mid-sentence in their first conversation with us, we just say, “Forget it.” And Charlie is pretty good at that, and I’m picking it up. (Laughter) It’s — we know very, very, very early in a conversation whether somebody’s talking about something that there’s any chance is actionable by us. And we don’t worry about the ones we miss. We want to make sure that we don’t waste any time thinking about things that, when we get all through thinking about them, we’re not going to know enough to make the decision on. So we just rule those out. And that rules a lot of things out.

But then, if it gets through a couple of these filters and makes it into an area where it says this is something that we know enough about to make a decision on, we’re ready to move right then. So we make decisions — we can make a decision in five minutes very easily. I mean, it just is not that complicated. Now, we know about a number of businesses and industries, and there’s a lot of businesses and industries we don’t know anything about. We know a lot of things about certain kinds of bonds, and we know — there’s a variety of things we know about, and it’s nice if we can expand that universe of knowledge. But the most important thing is that anything that gets through is in an area of knowledge. And the truth is, if we can’t make a decision in five minutes, we can’t make it in five months. You know, we’re not going to learn enough in the followings five months to make up for the fact that we went in deficient in the first place. So it’s just not a problem around Berkshire.

If we get a call and somebody says either they’ve got a business for sale or — that’s what we’re going to get on the calls — or if I’m reading a paper, or a magazine, or an annual report, or a 10-K, and I look at a price and there’s a significant differential between price and value, we move right then. And Charlie and I don’t need to talk to each other about it. I mean, we both think the same way, and we have generally similar spheres of knowledge. Charlie?

CHARLIE MUNGER: It’s — the answer to your question is, we could make a lot of decisions about a lot of things very fast and very easily. And the — and we’re unusual in that respect. And the reason we’re able to do that is there’s such an enormous other lot of things that we won’t allow ourselves to think about at all. It’s just that simple. I mean, I have a little phrase when people make pitches to me, and about halfway through the first sentence, I say, “We don’t do startups.” They don’t exist. Well, if you blot out startups, there’s a whole layer of complexity that goes out of your life. And we’ve got other little blotter-out systems. And using those, we finally find out that what remains is still a pretty large territory that we can handle. You think that’s fair, Warren?

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: And an awful lot of giveaways that people, in the first sentence or two, throw out that, you know, we just know we aren’t — you know, it isn’t going to work. (Laughs) And we waste very — I would say — we waste a lot of time, but we waste it on things we want to waste our time on. (Laughs) We’re very selective about that, and then we’re good at it. We waste a lot of time. But we’re not going to waste it on things we don’t want to waste it on.

9. No thoughts on Mexican billionaire Carlos Slim

WARREN BUFFETT: Number 3.

AUDIENCE MEMBER: Mr. Buffett, Mr. Munger, thank you very much for this wonderful rite. Coming — my name is Jorge Garza (PH), and I’m coming from Mexico City. Coming from there, you have been occasionally compared to — or rather Carlos Slim has been occasionally compared to you, for other reasons than your love of the game of baseball. Can you please share your thoughts on him?

WARREN BUFFETT: Well, I — he came up once with two of his boys, and we had lunch. But that was probably 15 years ago. So I really have no special — I mean, you probably know a lot more about Carlos Slim than what I do. I read the news stories and all of that. And we had a perfectly pleasant lunch. But that was a long time ago. And, Charlie, do you have anything?

CHARLIE MUNGER: No. I think you speak for the total knowledge of both of us about Carlos Slim. (Laughter)

WARREN BUFFETT: We’ll go down the rest of the Forbes 400 for you, too, if you would like. (Laughter)

10. Human rights issues shouldn’t keep a country out of the Olympics

WARREN BUFFETT: OK. Number 4.

AUDIENCE MEMBER: Hello. My name is Andre Stalty (PH). I come from New York City, and I’m thrilled to be here. I’m greatly inspired by you. We follow you in our analyze business class in New York City, a small group of small investors. And my —

VOICE SHOTING: There are human rights violations in the Klamath.

AUDIENCE MEMBER: My question is, would you, or have you, considered asking Coca-Cola to withdraw sponsorship from the Beijing Olympics in light of the immense human rights violations in Tibet, possibly inspiring a new business model that would value humanitarian interest as well as monetary interest?

WARREN BUFFETT: Yeah. I personally — you know, I personally think that the Olympics — and I hope they are — you know, conducted forever with everybody participating. I think that, personally, it’s a mistake to start deciding whether this country should be allowed and this country shouldn’t be allowed. (Applause.)

WARREN BUFFETT: I think it’s very hard to grade a couple hundred countries that might be participating, according to how their behavior was. I mean, we didn’t let women vote in the United States, you know, until 1920. So we went 140 or so, 130 years, and I would say that was a great human rights violation, but I would have hated to see the United States banned from the Olympics, you know, in the years prior to that because of that. So I just think it’s a terrible mistake to try to get into — the Olympics have a wonderful event. I think the more people participate in them, the better. And I think that, on balance, they contribute to a better world over time. So I would not start getting punitive about it. But I understand your motives on it. Thank you. Charlie?

CHARLIE MUNGER: Well, Warren understates my position. (Laughter)

WARREN BUFFETT: I usually understate his position. This is a man of strong opinion.

CHARLIE MUNGER: And I would say to you people who are distressed by imperfections in China, ask yourself your question — the question — is China more, or less, imperfect as the decades have gone by? And the answer is China is moving in the right direction. And as long as that’s happening, I think it’s a grave mistake to just pick the worst thing about somebody you don’t like and obsess about it.

WARREN BUFFETT: Yeah. The U.S. has moved in the right direction over years. (Applause.)

WARREN BUFFETT: Our Constitution said blacks were three-fifths of a person, you know. We’ve moved a long way, and we’re far from perfection. But I think you do better with people that you’re working with to — if they’re going in the right direction, largely, to encourage them. You may want to nudge them a bit, but I don’t think the Olympics is the right way to do it.

11. We’ll reduce our reliance on coal, but not soon

WARREN BUFFETT: Let’s go to number 5.

AUDIENCE MEMBER: Hi. My name is Jessica Helmers (PH), and I’m from Scottsdale, Arizona. My question is, what future trends do you see in the coal industry? Do you think its cost advantage will outweigh its environmental impact?

WARREN BUFFETT: Well, I think in the short-term the world is going to use more coal, you know, and I think that there’s no question that there’s an environmental disadvantage to it. And as the — I think the world will slowly — maybe more rapidly than that — but we will figure out better ways to do the things that coal does, that will be more environmentally friendly over time, but it isn’t going to happen fast. I mean, if you shut down the coal-generated utilities in the United States, you know, this — we would not be able to hold this meeting in a room with the lights on. So it’s a very tough problem to solve, or to even make big inroads on in a short period of time. Now, we — at MidAmerican — we’ve put in a lot of wind capacity in the last five years or so — probably about as much as anybody has. But we are dependent a lot on coal. It’s cleaner coal than it was 20 years ago, but — and we will be dependent on it for a long time. And, you know, it’s a worldwide problem, obviously.

The Chinese are building coal plants at a very rapid rate. It’s going to require cooperation and leadership on a worldwide scale. And, frankly, the United States is not in a great position in terms of leadership because, you know, per capita, we’ve done as much to this planet of a negative nature as any country in the world. So we — it’s a little tough for us to go around preaching to people, but we will need a leader, in my view, that can sort of transcend our record of the past and get cooperation from major countries around the world. I don’t think it’s going to be — but I don’t think it’s going to be fast. Charlie is less pessimistic on this than I am. Charlie?

CHARLIE MUNGER: Well, I think the people who are very against the use of coal should reflect: which one they’d rather use up fast — the hydrocarbons, the oil and natural gas, or the coal? I would rather use up the coal because it’s less desirable as a chemical feed stock for what we need to feed the world. And so I would argue that there’s an environmental reason, in terms of human kind, for being very pro-coal use. Most people don’t think that way, but I do. (Laughter)

WARREN BUFFETT: Charlie does not find comfort in numbers.

CHARLIE MUNGER: No.

12. Don’t lump regional banks together

WARREN BUFFETT: Number 6.

AUDIENCE MEMBER: My name is Rosat Bastar (PH). I live in Sacramento, California. The stock prices of most small, regional banks have become more attractive in the past one year. Do you have any opinions about regional banks as investments? And if you were going to purchase shares, what are the areas that you would carefully examine?

WARREN BUFFETT: Yeah. I don’t think you should make a categorical decision about something like — however you define them — small, mid cap, whatever, regional, or national banks for that matter. So much depends on the character of the institution, which will probably be a reflection, to a great degree, of the type of CEO you have. And I — a bank can mean anything. It can — you know, it can mean an institution that’s doing all kinds of crazy things. It can — there was one called the Bank of the Commonwealth up in Detroit many years ago that went to extremes, and it was very popular on Wall Street for a while. It could mean the soundest of institutions. We had one — we owned a bank — the only bank Berkshire’s ever owned in its entirety — in Rockford, Illinois, run by a fellow named Gene Abegg. And, you know, it wouldn’t make any difference whether it was a super-regional or a regional or a small or a mid-cap bank, there’s no way Gene Abegg could run anything other than a super-sound bank.

So I don’t think you should — I think you should know something about the culture of the management and the institution to make a firm buy decision on a bank, and that’s hard to do for 99 percent of the banks. We own stock, as you know — it’s in our report — Wells Fargo and U.S. Bank and M&T up in Buffalo. And in all three cases, I think I understand quite well the DNA of the institution, in terms of how it behaves. That doesn’t mean those places are immune from problems, because they’ll have problems. But it means — but it does mean — they’re immune, in my view, from what I would call institutional stupidity. And I would not say that all banks are immune from that. As a matter of fact, there was a very wise man named — I think it was Morris Cohen (Morris Schapiro) — that said, “There are more banks than bankers,” and if you think about that awhile, you’ll get my point. (Laughs) Charlie?

CHARLIE MUNGER: Well, I think the questioner is onto something. So many of our very large banks, both here and in Europe, have sort of cast a pall of disgrace over the whole industry, and that is undoubtedly pounded down the stocks of some small banks that there’s nothing at all wrong with. So I think you’re prospecting in a likely territory.

WARREN BUFFETT: Yeah, but you can find a few big banks —

CHARLIE MUNGER: Yes. (Crosstalk)

WARREN BUFFETT: And it — I don’t know if you took the 20 smallest banks in Florida and the 20 largest banks in Florida which group would be in better shape, in terms of the Florida real estate situation.

CHARLIE MUNGER: It’s a territory that has some promise. (Laughter)

WARREN BUFFETT: That is a wildly bullish statement from Charlie. (Laughter)

13. Nuclear proliferation is the “primary problem of mankind”

WARREN BUFFETT: Number 7. I’m going to go out and buy that stuff as soon as we get out of here. (Laughter)

AUDIENCE MEMBER: Good afternoon. My name is Matt Thurman (PH), Chicago, Illinois. Mr. Buffett, Mr. Munger, what are your thoughts on preventing further nuclear proliferation, given recent events in Syria, Iran, North Korea, and other countries? Thank you.

WARREN BUFFETT: Yeah. Well, it’s the great problem of mankind, along with proliferation or the spread of other weapons of mass destruction in the chemical and biological field. The genie is out of the bottle on nuclear knowledge, and more and more people are going to know how to do enormous damage to the rest of the human race as the years go by. You’ll have a given percentage of the population that are psychotics or megalomaniacs or religious fanatics or whatever, and will wish ill on their neighbors. And the choke point will be — presumably — will be materials, and to a degree, deliverability. I think there — people generally associate weapons of mass destruction threats these days with terrorists and rogue organizations of some sort and not so much with nations. But I regard both as being enormous threats to the future of mankind, and we have not made much progress in that respect to — we should be doing everything possible to reduce access to materials — and I’ve even had a few thoughts on that which you can look up on the Nuclear Threat Initiative, probably on the website.

And we’ve got a proposal, actually, that might reduce by a tiny bit the rationale, at least, for all kinds of nations having highly-enriched uranium and that sort of thing. But it’s the — it is the primary problem of mankind. If you’ve got 6 1/2 billion people, you’re probably going to have — in the world — you’re probably going to have close to twice the number of people who wish ill on their neighbor than you had when you had 3 billion people. And for a long time, if you were a psychotic or something, you could pick up a stone and throw it at the guy in the next cave, and you moved onto bows and arrows and rifles and cannon. But for millennia, the ability to inflict massive damage was quite limited, no matter how crazy you were. And since 1945, when Einstein said that the atomic bomb, as they called it then, “has changed everything in the world except how men think.” That was a comment made shortly after Hiroshima.

We live in a world where exponentially — has experienced exponential growth — in the ability to inflict harm on somebody else, and we haven’t gotten rid of the nuts or the people who want to do it. And it is — whether it’s, you know, Iran or you name it, or whether it’s terrorist organizations or whatever, you know, we live in a very, very, very dangerous world on that that is getting more dangerous as we go along. And we’ve been very lucky since 1945, you know, when the Cuban missile crisis came along in the ’60s, you know, it might have been 50-50, and I think we were lucky we were dealing with Khrushchev and we were lucky that Kennedy behaved the way he did. But we were lucky, and Charlie and I talked a lot about it in the ’60s at the time. But it won’t go away. And you would hope, at least in the United States, that we have an administration, whether it’s Republican or Democrat, where that’s at the top of the agenda, trying to figure out a way to minimize that risk. You can’t eliminate it.

It is out of the bottle. But we’ve got to — it should be paramount to minimize the risk that we really get into something that involves, you know, deaths on a scale that nobody’s ever contemplated before. Charlie?

CHARLIE MUNGER: Yeah. Well, you talk about deaths on a scale that people have never contemplated before. People have recently figured out that the population of Mexico probably had a population decline of 95 percent caused by European man bringing in his pathogens. And it was a pretty big civilization that went through that little knothole. These things can happen and have happened. And look at Mexico today. I don’t think it’s going to wipe out the species.

WARREN BUFFETT: Well, that’s —

CHARLIE MUNGER: I hope that cheers you up. (Laughter)

WARREN BUFFETT: The cockroaches will survive. It’s a very good question. I wish I knew a better answer.

14. Buffett’s advice for young people

WARREN BUFFETT: Number 8.

AUDIENCE MEMBER: Good afternoon. I’m (inaudible) from Apopka, Florida. I would like to thank you for this wonderful opportunity to learn so much more about finances and, at the same time, have a wonderful time. It’s been fun.

WARREN BUFFETT: That’s great.

AUDIENCE MEMBER: I teach at Valencia Community College in Orlando, Florida. I teach office administration and business. I applaud my students for investing in themselves by enrolling in college. I also want to stress financial independence and financial freedom. I do this by telling them that slow and steady wins the race; also, good, sound financial management; and then the law of reciprocity. I have them track every expense over a period of time. Also they buy, theoretically, one stock and track that, too, over a period of time. We keep track of the current financial news, current news, and also they have research papers. (Applause.)

AUDIENCE MEMBER: Thank you. (Laughter) They research FICO scores, the credit reports, Clark Howard, Suze Orman, the top ten billionaires, not because — (Applause)

WARREN BUFFETT: I think — Could you move onto your question, then, please? (Laughter)

AUDIENCE MEMBER: Yes.

WARREN BUFFETT: But thank you.

AUDIENCE MEMBER: OK. What else should I be doing to lead them — (laughter) — to make sound financial decisions and to have happy, sound financial life?

WARREN BUFFETT: I’m ready to hire your entire class right now. (Laughter) Well, I think you’re telling — you’re giving them some very good advice. I think that the most important investment you can make is in yourself. I mean, very, very, very few people get anything like their potential horsepower translated into the actual horsepower of their output in life. And potential exceeds realization to just an enormous factor with so many people. And I — one illustration you might try with your class — I tell them this when I talk to high school groups — just imagine that you’re 16 and I was going to give you a car of your choice today, any car you wanted to pick, and — but there was one catch attached to it — it was the only car you were going to get in the rest of your life, so you had to make it last there. You can pick out the fanciest you want, a Maserati, whatever it might be. How would you treat it? Well, of course you would read the owner’s manual about five times before you turn the key in the ignition. You’d keep it garaged.

Any little rust, you would get taken care of immediately. You’d change the oil twice as often as you were supposed to, because you know it has to last a lifetime. And then I tell the students, you get one body and one mind, and it’s going to have to last you a lifetime, and you better treat it the same way, and you better start treating it right now, because it doesn’t do you any good to start worrying about that when you’re 50 or 60 and the rust — that little speck of rust — has turned into something big. So anything your students do to invest in their mind and body — particularly your mind — we didn’t work too hard on the bodies around here, but — (laughter) — you know, it pays off. It pays off in an extraordinary way. Your best asset is your own self. And you can become, to an enormous degree, the person you want to be. When I get classes in universities, I just ask them to imagine they were going to buy one of their classmates to own 10 percent of for the rest of their life. Which one would they pick?

They wouldn’t pick the one with the highest IQ, or necessarily the one with the highest grades. They’d pick the person that’s going to be effective. And the reason people are effective is because other people want to work with them. They want to be around them. And other people they don’t want to be around. And those are qualities than an individual picks up — being generous, being humorous, being on time, not claiming credit for more than you do but rather less than you do, helping out other people — all kinds of human qualities that turn other people on, and then there’s things that turn other people off. And those are habits, and they’re the habits that you pick up when they’re the age of your students. The habits they have today will follow them throughout life, so why not have good ones? So that’s the only message I would give your students. (Applause)

CHARLIE MUNGER: Well, I’ve got a specific suggestion that answers your specific question. I would add to that extensive repertoire of yours by teaching them to avoid being manipulated to their disadvantage by vendors and by lenders using the standard tricks of the vendor and lender trade. And you couldn’t start with a better book than Cialdini’s “Influence,” and I think Bob Cialdini, who is a shareholder, is here somewhere in this audience. And so I have a new textbook to — I suggest you add to your class — which is Cialdini’s “Influence.” And he’s just got a new book that’s coming out and for sale in Omaha today, I think, for the first time, and that’s called “Yes.” So here’s two books that I suggest you add to your class.

WARREN BUFFETT: OK. (Applause.)

15. Buffett on owning sports teams

WARREN BUFFETT: Let’s go to number 9.

AUDIENCE MEMBER: I’m Andrew (inaudible) from Chicago, Illinois, and I’m nine years old, and I’m a big baseball fan. I know you like baseball, and my favorite team is the Chicago Cubs. Would you like to buy the Chicago Cubs from Sam Zell? (Laughter) And my question is, do you think buying baseball teams is a good investment? (Applause)

WARREN BUFFETT: Well, it’s been a good investment. It’s been a good investment. It’s not been a good investment necessarily because the earnings have gone up so much, although cable television multiplied the value in a big way. In effect, television expanded the stadium. Wrigley Field, I think, probably seats less than 40,000, maybe. So you had 40,000 seats available when I went there for my first major league baseball game in 1939. But then along came television, and then cable television, and pay — in effect, pay-cable television for baseball or sports networks, and that multiplied the seats in a huge way. Now, a lot of that went to the players, but some of it stuck to the owners. I am not a — when I was your age, I would have thought if I made a lot of money, I would have bought a team. But there were a lot of things I thought I would do then — (laughter) — I haven’t done subsequently.

So, I don’t think — if the Cubs sell for 700 million, and you’ve got a percentage of that in your bank account — now, I don’t think I would buy in at that price. There’s a psychic income to many people in owning sports teams. I mean, it makes them famous. Maybe not in the way they anticipated when they bought the team, but the — you know, it is a way to instant celebrity and recognition and all that. And as long as we live in a society where people have loads and loads of money, a certain percentage of people are going to want to become known for the fact that they have done very well in life, and a sports team is certainly one way of doing it. That isn’t the only reason people buy them, obviously. But I will say this, you are not the first one that’s asked me about buying the Cubs. (Laughs) I’ve had calls — not from Sam — but from other people, and it’s — I think I’ll leave that to you. Charlie? You know anything about buying a sports team? He would be a tougher sell than I would.

I might do something kind of stupid like that, but —

CHARLIE MUNGER: Well, you’ve already done it once.

WARREN BUFFETT: Yeah. (Laughter) Touche.

16. U.S. may be so rich it doesn’t need to save

WARREN BUFFETT: Number 10.

AUDIENCE MEMBER: Mr. Chairman, Mr. Vice Chairman, my name is Andy Peake (PH), and I’m from Weston, Connecticut. Americans at the individual, municipal, state, and federal levels, historically, do not save. On the other hand, Asians save approximately 40 percent of their income. Living beyond one’s means is an American way that obviously cannot continue. First, why is it that Americans do not save, and, secondly, what can we do to correct this longterm problem? Thank you.

WARREN BUFFETT: Yeah, well certainly the savings rate in this country is — has fallen significantly and may even be negative, although it does seem to me that the value of the country, in real terms, I think, does increase quite significantly decade to decade. So I’m not sure exactly how it happens without savings, but it does seem to me that this country, as a whole, is worth considerably more than it was 10 or 20 or 30 or 40 years ago, in real terms. So something good has happened. But the propensity to save, that almost seems innate, in at least the great majority of cases. I mean, we’ve got our friend from Florida teaching children to save, and I think that has some impact. And I should have thanked Andy Heyward for that terrific cartoon this morning, and he’s got a program that I’m participating in that we think — in cartoon form — might influence a few younger people towards saving. If you own Berkshire stock, you’re automatically saving, because we retain earnings, and you’re indirect interest in those retained earnings is a form of saving.

So you can spend every dollar of your income that comes in the other way, and if you own Berkshire, you are, net, saving, which is a practice I have now been following for 40 years. Sometimes to my family’s consternation. I don’t know that the — you know, the savings rate is based on calculations made on consumption and imports and so on. We are importing $700 billion more of goods and services than we’re exporting. And that means that somebody else is doing our savings for us, basically, as we export ownership and claims against America. I think that’s going to have consequences over time, but we are so rich that it may not be really apparent. I think the average American’s standard of living is going to improve, in real terms, although I think it may be very, very, very disproportionate, the extent to which the — particularly the super-rich — benefit compared to those in the middle class. But, net, I think the country will be — even with our present policies, the net — in net real terms, the value on a per capita basis of the country will increase from decade to decade.

But nothing like it will, in places like a China or Korea percentage-wise, where the savings rate is very high. This country may not save very much because it may not need to save very much. We have $47,000 of GDP per capita. It may not be distributed very well, but we are one very, very, very rich country. And a very rich country may not need to save as much as a country that’s trying to reach its potential. Charlie?

CHARLIE MUNGER: I’ve got nothing to add to that.

17. Why Buffett is going to Germany

WARREN BUFFETT: OK. Number 11.

AUDIENCE MEMBER: Mr. Buffett, Mr. Munger —

WARREN BUFFETT: This sounds serious.

AUDIENCE MEMBER: My name is — (Laughter) I’m used to that. My name is Uta Bauda (PH) from Munich. Again, a guy from Germany. We’re going to meet in around about 14 days’ time again in Germany, in Frankfurt at the Union Club. May I ask you a little bit ahead of the others, what your reasons for coming to Germany? Thank you.

WARREN BUFFETT: Yeah. It’s very simple. We want more — not that there have been hardly any so far — but we would like more family owners of German businesses — in some cases in the family, maybe a hundred years, maybe 20 years, whatever it might be — we want more owners who, when they feel some need to monetize their business, think of Berkshire Hathaway. We want to be on their radar screen. We want to be in the same position — we want them to be in the same position that the Wertheimer family was or Paul Andrews’ family was here not so long ago, or the Pritzker family was. When they have some reason — could be a variety of them — that they wanted to convert a — the ownership of a good — very good — company about which they care a great deal — translated into money, to think about calling us. And if they care about their business, we are their best call.

And I don’t think we’re anywhere near as prominent on the radar screen in Germany as we are in the United States, and it’s something I probably should have done more about earlier, but now I’m going to hit four countries in Europe in a few weeks. And when we leave, I think we’ll be somewhat better known — what we’re looking for, what we can do for those companies, why they should give us a call — I think we’ll be better known a month from now than we are now. Charlie?

CHARLIE MUNGER: Yeah. And Germany is a particularly advanced civilization, in terms of inventiveness and engineering. You go into an American printing plant now, and the names on the machines are all German — not all, but mostly. Now, some of the German names are Germans that came over here to America and formed printing equipment businesses. But it’s just amazing the influence that the Germans have had on field after field in America. It’s a very logical place for us to be looking.

WARREN BUFFETT: Sounds like maybe Charlie should go. (Laughter)

18. Munger on housing: A “particularly foolish mess”

WARREN BUFFETT: Number 12.

AUDIENCE MEMBER: My name is Len Yaffe. My wife, Ruth, and I live in Tiburon, California. I was wondering if the current economic stresses remind you of any prior period in U.S., or any other nation’s, history, and, if so, is there anything we can learn from the prior period that might help us manage the current period better?

WARREN BUFFETT: Well, they’re all a little different and they all have similarities. But this one, obviously, had more of its origins in the mortgage field and in terms of the residential real estate bubble. But the troubles that begin in one area have a way of spreading to other areas. But I would say that, in my lifetime, it’s been — I can’t remember one where this particular residential real estate bubble has sent out the shock waves and the exposure of other practices elsewhere to — as to their weaknesses — like this one. But I don’t think there’s any magic to the analysis or anything like that. I think that some stupid things were done that won’t be done soon again, and they won’t be done exactly the same again, but variations of them will pop up at some point. Because humans are what lead to stupidity in behavior, and there are these sort of primal urges that — in terms of getting rich and using leverage and all of that sort of thing, and wanting to believe in the tooth fairy — that pop up from time to time in human behavior, and sometimes they pop up on a very big scale.

The — in terms of having any great insights on solutions or anything of the sort, I don’t have them. Charlie?

CHARLIE MUNGER: No. It was a particularly foolish mess. Now, at earlier meetings we talked about some idiot that decided that a credit delivery grocery business, like the old Buffett store —

WARREN BUFFETT: Webvan.

CHARLIE MUNGER: Yeah, Webvan. You know, internet-based delivery service for groceries. A really asinine idea. (Laughter) And, of course, it met an ignominious failure. That was smarter than what the people did in this mortgage field. (Laughter) It was a lot smarter. I just wish we had those brilliant people back that gave us Webvan. (Laughter) Which, by the way, reminds me of my general attitude toward political developments. I have a rule and it’s as follows: the politicians are never so bad you don’t live to want them back. (Laughter)

WARREN BUFFETT: Pollyanna. (Laughs)

19. Financial crisis-era assets should be valued at market

WARREN BUFFETT: Number 1.

AUDIENCE MEMBER: I’m Bob Kline (PH) from Los Angeles. Following up on the last question, can you speak to the accuracy of the financial statements of the world’s major financial institutions? What should be done to properly value their assets, like mortgages, leverage loans, CDOs, and other assets that are, as Charlie says, as good until reached for? Since the leverage at these banks and brokerage firms is generally 15 to 20 times their tangible net worth, there isn’t much margin for error. So what can be done to improve the integrity of financial statements?

WARREN BUFFETT: Well, it’s a very tough thing. I still lean strongly — there’s a lot of controversy now about whether you should use fair value, however that may be determined. In many cases, it’s very hard to determine. But whether you should use that or some other figure like cost because people say that the present values are unrepresentative and so on. I think that you get into more troubles as a society when you start openly valuing things at prices that make no sense in terms of what’s going on, than whether you do your best to estimate them, even though those estimates may prove, many cases, optimistic later on, and certainly inaccurate in some respects. So I would stick with financial institutions at least having to attempt to report their assets on a fair value basis. But when you get into instruments — I’ve used this illustration before — but when you get into a CDO-Squared, if you read a standard mortgage — residential mortgage-backed certificate — security — it may consist of thousands of mortgages backing up this instrument.

And then that instrument may be traunched into 30 or so different traunches where each party has a different claim on the waterfall of funds received. Now, that instrument itself can be kind of difficult to understand. But then you take that and you create a CDO by taking some of the lower junior tranches of a bunch of these RMBSs, maybe 50 of them, and then you create a CDO out of this. So now you create, out of a whole bunch of junior — and perhaps — and very correlated — and perhaps kind of lousy instruments — and then you put them in a CDO and say that because you put them all together and diversified, in theory, you’ve got a lot of triple-A traunches of that — was a big error to start with. And then when you took the lower tranches of a bunch of CDOs and stuck them into a CDOSquared, that was nuttiness squared. And if a residential mortgage-backed security had a 300 page prospectus and you had to read 50 of those to understand a CDO, you’re up to 15,000 pages.

And if you had to read 50 more CDO prospectuses, and the material behind that, to evaluate a CDO-Squared, you had to read 750,000 pages, presumably, to evaluate one security, and that was madness. To let people value that sort of thing, because they say the market at ten cents on the dollar is unrepresentative, so instead of using that, I’ll use the hundred cents I paid, I think would be an abomination. And I think that the discipline, mild as it may be, of telling managements that you’re going to have to value this stuff at market may keep them from doing things that they would otherwise do that would be very stupid if they think they can get away with valuing them at some fictitious — or at cost — which would be fictitious, in terms of markets. I lean toward the market value approach. I don’t know — when you get into really complex instruments — I just don’t know how you value them.

Charlie was on the audit committee at Salomon, and they would spend hours and hours and hours — and I think you found one that was mismarked by 20 million or something like that, back when 20 million was real money.

CHARLIE MUNGER: It was a floating plug.

WARREN BUFFETT: Well, we had the floating plug, too, yeah.

CHARLIE MUNGER: No. I — there’s a lot that goes on in the bowels of American industry that is not pretty. (Laughter)

WARREN BUFFETT: So you can add sausage and laws — maybe you should add accounting practices to the things that people shouldn’t have to witness the making of. (Laughs)

CHARLIE MUNGER: I think that part of the trouble comes from some prominent members of my own Republican Party. Some of these people overdosed on Ayn Rand and what they learned in Economics 101, and they sort of got to thinking that if anything happened as a natural response of human nature in a free market system, even if it was an ax murder, it was a desirable development and part of a wise distribution of risk. I don’t know why grown-ups get these silly ideas, but they do. And one of them headed the Federal Reserve. I think Alan Greenspan did a very good job, averaged out, but he did overdose a little on Ayn Rand, and he had this tendency to believe that, if it happened in a free market, it had to be all right. I think there’s some things that should be forbidden. And I think that the world would have worked better if a lot of things that were described as follows: this is a financial innovation which will diversify risk — if that phrase had been banned from all discourse, the country would have worked better. (Applause.)

20. Plea from audience to read the U.S. Constitution

WARREN BUFFETT: Area 2.

AUDIENCE MEMBER: I’m Larry Tidrick (PH) from Elk Grove Village, Illinois. My question is really more a plea. Get out your copies of the U.S. Constitution, read over Article 1, Section 8, the enumerated powers; the Ninth Amendment; the Tenth Amendment; and give Roger Pilon a call at the Cato Institute. I think everything that’s gone on today, regarding finance and economics, has to do with our Constitution, which was really based upon property rights and contract rights.

WARREN BUFFETT: Do you have a question, though, or not?

AUDIENCE MEMBER: Yes, sir.

WARREN BUFFETT: OK.

AUDIENCE MEMBER: Well, no, I don’t. (Laughter)

WARREN BUFFETT: I sort of suspected that.

AUDIENCE MEMBER: I made — yeah. I made the plea and —

WARREN BUFFETT: OK.

AUDIENCE MEMBER: — that’s really it.

WARREN BUFFETT: OK. Well, thank you.

21. American’s distaste for mass transit won’t change soon

WARREN BUFFETT: We’ll go on to number 3.

AUDIENCE MEMBER: Yes. My name is Dan Schmidt (PH) from Burnsville, Minnesota. And I’d like your opinion on the future of mass transit and how it relates to railroads, and will these transit systems and railroads be expanding in the future?

WARREN BUFFETT: In terms of passenger traffic?

AUDIENCE MEMBER: Correct.

WARREN BUFFETT: Yeah. The American public, basically, doesn’t like mass transit. I mean, it endures it when it needs to, but there — the American love affair with the car, which translates to aversion to mass transit, is sort of overwhelming. I used to be involved in bus companies. And, you know, you can make all kinds of rational arguments to people about the use of mass transit, but one person to a car seems to be an enormously popular method of moving around. And I think it’s unlikely that we see a large expansion in mass transit in this country. I think the American public is, for one reason or another, whether they’re trained to it or whether it’s just something in their genetic makeup, they do not like going out and waiting for buses or whatever it may be or trams. And they want to get in their car. And even with gas at close to $4 a gallon, they want to go someplace and pay a lot of money to park, and they don’t want to double up in the cars very much. And that just seems to be human nature.

Maybe it will change, but I never like to bet on something that has gone in one direction for a long time reversing unless the evidence is pretty strong. Charlie?

CHARLIE MUNGER: You have a more optimistic view of it than I have. (Laughter)

22. Munger’s in “awkward position of agreeing with Al Gore”

WARREN BUFFETT: Number 4.

AUDIENCE MEMBER: Hi. I’m Tom Nelson (PH) from North Oaks, Minnesota. My question is for Charlie. If you were in charge of this country, how would you handle Al Gore’s alleged climate crisis?

CHARLIE MUNGER: Well, of course, I’m in the awkward position of agreeing with Al Gore that we shouldn’t be burning up so many hydrocarbons. (Applause) I’ve just got a different reason. His brain doesn’t work the way mine does, and you’ll have to judge for yourself which you prefer. (Laughter)

WARREN BUFFETT: We’ll have a vote a little later. (Laughter)

23. Disagreement on danger of CDOs

WARREN BUFFETT: Number 5.

AUDIENCE MEMBER: Good afternoon, Warren and Charlie. This is Frank Martin from Elkhart, Indiana.

WARREN BUFFETT: Nice to have you here, Frank.

AUDIENCE MEMBER: Thanks, Warren. One of my favorite aphorisms from you is, “To win, first you must not lose.” The excerpt that you read a few moments ago from the 2006 annual report contemporized that aphorism, and I think was both prescient and prophetic. Notice I said “prophetic” and not “pathetic.”

WARREN BUFFETT: I noticed.

AUDIENCE MEMBER: Yeah, thank you. (Laughter) On several of occasions disagreeing with Alan Greenspan, you have called derivatives “weapons of financial mass destruction.” We both have our own record as believing the country is currently in recession. If corporate default rates, which are currently benign, escalate — should the recession deepen and we get back to default rates common in 2002 or back in the early 1990s — will the credit default swap problem materialize as a serious threat to financial stability? I respect you as one of the all-time great pricers of risk. You and Charlie must consider selling insurance without reserves, without really understanding pricing risk, to be an abomination. Is there a chance, in your judgment, that the CDS market may eclipse the subprime mortgage market as the next element of the financial meltdown?

WARREN BUFFETT: The credit default swap market — you can see these figures — and I’m repeating them, but I’m not validating them — but the last number that came out was over 60 trillion. Now, there’s lots of double counting in these things and all that sort of thing. But there’s no question there’s a lot of money on both sides of the credit default market. They call them credit default swaps. You can think of it as insurance against a company going bankrupt. And actually, we have written two types of derivatives on a big scale. We explained them in the annual report. We explained them again in the press release that was issued yesterday. And we have insured in the — we’ve written insurance that pays off to somebody else in the event of default by companies listed on given indices. There’s a high-yield two, a high-yield three, and so on, through high-yield nine. And we’ve written various traunches of risk on those things, and I think we’re going to make significant money, although we could lose money, too.

It will depend on credit experience in the next few years. I think there’s no question that the corporate default rate will rise. That’s been cranked into the calculations I make in writing this insurance. The question of whether the credit default swap — the size of that market — will lead to any kind of chaos in the financial markets, I think probably not. Although if a Bear Stearns had failed, for example, you would have had a huge unwinding of contracts by counterparties who had to establish their claims and all that. So you would have had rather chaotic conditions. Any time — a credit default swap is merely a payment by one party to another. So it’s a negative-sum item. When somebody loses money on a subprime loan, on a mortgage loan, they’ve lost real money. Now, somebody may be buying the house later on cheaper than they would have bought it earlier on, but there is not an equivalent swap of dollars at the time that a subprime loan goes bad. With the credit default swaps, there is a swap of dollars. So as long as the counterparties pay, if A is up a million dollars, B is down a million dollars.

And the question is, is if you get a Bear Stearns-type situation that didn’t get interrupted by the Fed, whether counterparties would fail and you get a lot of trip hammer effects, I don’t think that’s going to happen, and I think the chances of it happening were reduced significantly by what happened — by the fact that the Fed stepped in at Bear Stearns. We’ve had enormous payments from one party to another, in terms of credit default swaps. Just — there’s a firm called Fairfax Financial that made — a relatively small firm — that made, as I remember, well over a billion dollars in credit default swaps. Well, somebody else lost the billion, but it didn’t pose a threat to the system. It posed a threat to the guy that lost the billion, but he had to keep up putting up collateral, presumably, as he went along. So it wasn’t like he was called overnight for the billion. So even though credit defaults — they’ve been the most volatile of instruments in the last 18 months.

There’s been nothing that’s swung as much — maybe there’s some subprime index that has — but virtually it’s credit default swaps. And that really hasn’t created a problem in the system. So I do not think — particularly if the Fed is going to step in when they see investment banks that they regard as too big to fail, or banks too big to fail — I don’t think that that will probably be the cause of the problem. It may be a cause of enormous losses to some institutions, but those will be matched by enormous gains by other institutions. I do think there’s that — the problem of the overnight disruption in the system, which Bear Stearns, I think, would have produced. But maybe something else could produce it — a nuclear bomb going off in Manhattan, you know, or something of the sort. That kind of thing — where there’s a discontinuity, where the collateral posted the previous day was totally inadequate in terms of the kind of movement that occurred — certainly at that time something like having a large amount of CDSs out there, it could cause a — it could exacerbate — the chaos to a considerable degree. Charlie?

CHARLIE MUNGER: Well, I think the answer to your question is — could we have a big-time mess out of credit default swaps — is yes, we certainly could. I think the stupidity, while it’s extreme, is not as bad as sweeping bums off skid row to give them mortgages to buy houses, but it’s pretty bad. One of the things that’s interesting about credit default swaps, which isn’t much commented on, is, let’s say you’re insuring against the outcome that people will lose money on a hundred million dollar bond issue. And the credit default swaps, instead of amounting to a hundred million, amount to 3 billion. Now you’ve got people with $3 billion worth of contracts that really have a big incentive in having somebody fail. And, of course, they may manipulate, in some fraudulent or extreme way, with the little loss in order to make the big collection. It was insane for the regulators to allow this outcome to occur in America.

It used to be illegal for people who had no insurable interest just to buy life insurance on people they didn’t know, because society was afraid that people would do that and then kill the person. And that happened in Los Angeles. We had sweet, little, old ladies that got bums off skid row. They’d take out life insurance on them. And when two years went past, they murdered them with fake hit-run accidents. So human nature is up to this kind of venality where you have big payoffs. And why we wanted these enormous bets to be made, in relatively unregulated markets, where the bets are 10, 20 times the size of the original bond issue, it’s crazy. If I did this as a satire, you’d say I was overstating. I’m understating. We have a major nut case bunch of regulators and proprietors in this field. (Applause.)

WARREN BUFFETT: Charlie, one; invisible hand, zero.

24. Buffett’s test on when to pay a dividend

WARREN BUFFETT: Let’s go to number 6.

AUDIENCE MEMBER: Hi, Mr. Buffett and Mr. Munger. My name is Neharick Aneela (PH), and I’m from Houston, Texas. I’m a seventh grader, and I’m 12 years old. I was wondering why you do not believe in dividends, Mr. Buffett, when your mentor, Ben Graham, believed in dividends? He influenced you in so many ways, but why weren’t you influenced into believing in dividends? Thank you.

WARREN BUFFETT: Well, I had to show a little individuality in some respect. (Laughter) Well, the answer is I do believe in dividends in a great many situations, including many of the ones at companies in which we own stock. The test about whether to pay dividends is whether you can continue to create more than one dollar of value for every dollar you retain. And there are many businesses — take See’s Candy, which we own. See’s Candy has paid everything, virtually, out to us that they earn because they do not have the ability within See’s Candy to use large sums, which they earn, intelligently in their business. So it would be an enormous mistake for See’s Candy to retain money. So they distribute to Berkshire, and we hope that we move that around in some other area where that dollar becomes worth $1.10, or $2.10, in terms of present value terms. If we do that, the shareholder — whether they’re taxable or whether they’re not taxable, whether they’re a foundation or whether they’re living on income, even — they are better off if we retain the money.

Because if they were going to get a dollar in dividends and it became worth $1.10 or $1.20 in market value immediately on a present value basis, they’re better off selling a small percentage of their stock and realizing the required amount that way, and they will have more money when they get all through doing that than if we paid it in dividends. But if the time comes — and it will come someday — when the — if the time comes when we don’t think we can use the money effectively to create more than a dollar of market value per dollar retained, then it should be paid out. And, like I say, we do that individually within Berkshire. But because we have this ability to redistribute money in a tax-efficient way within the company, we probably had more — we had more reason — to retain all of our earnings. If See’s Candy were a standalone company, we would simply pay out a lot of the earnings, practically all of the earnings, in dividends. Just like we do now, except it goes to Berkshire. We like our — we like the companies in which we have investments to pay to us the money they can’t use efficiently in their own business.

In some cases that’s a hundred percent of what they earn; in some cases it’s 0 percent of what they earn. We own some stocks that don’t pay any dividends. Costco paid a very small — did they pay any dividend for a while, Charlie, or —?

CHARLIE MUNGER: They — while they were growing very rapidly, they paid no dividend. And finally they are paying one. Berkshire’s policy is much the same. Warren has always planned on paying large dividends out of Berkshire, and he does it in the mode of Saint Augustine when he said, “God give me chastity, but not yet.”

WARREN BUFFETT: Right. I’ve always admired that.

25. Electricity in the Southwest

WARREN BUFFETT: Number 7.

AUDIENCE MEMBER: Good afternoon, Mr. Warren Buffett, Charlie Munger, shareholders. My name is Richard Meyers (PH). I’m from (inaudible), California. In respect to your opinion earlier, I will go down to southern California, Arizona, and ask a question: if you have knowledge or interest of the corridor for electricity coming in from Arizona into California, or is it going from California back into Arizona? As California is known as a sunny state, we should be able to have our own solar systems. I have one more. I have saved $20 by staying in line since 2:30 this morning, and I would like to know which one of these books that I could buy that would do me the most good and my tribe. Thank you.

WARREN BUFFETT: Well, tell us about the books. You mean the whole list?

AUDIENCE MEMBER: Which one I can buy for $20. (Laughter)

WARREN BUFFETT: Probably the ones that haven’t sold very well today. (Laughter) Yeah, I’m not that familiar with the prices of the books. We try to have a good selection in there. I’m a little partial to Larry Cunningham’s books because — Larry Cunningham’s book — because it consists of a rewriting of all my own stuff. (Laughs) But, no, we — I think the whole collection is fine. I wouldn’t want to recommend one over the other. And I know nothing about that first subject. Charlie, do you?

CHARLIE MUNGER: Well, I know a little. You know, California did cause coal plants to be built near the Grand Canyon because California didn’t want the pollution and it needed the electricity and they were nearer the coal mines. And eventually that caused huge uproar, a lot like we heard about the Klamath River. And the Grand Canyon, that started having some visibility problems. And I think those things are, maybe, decommissioned, or about to be decommissioned, so it’s a very complicated subject. And I’m glad to (inaudible) it back to you.

26. Berkshire’s international ambitions

WARREN BUFFETT: OK. Number 8.

AUDIENCE MEMBER: Good afternoon, Mr. Buffett and Mr. Munger. My name is Argin Row (PH). I am in the eighth grade and live in Pearland, Texas. I ask everybody to call me Tony after reading your 2006 annual report. (Buffett laughs) My question is, do you foresee Berkshire buying any businesses in either India or China in the near future?

WARREN BUFFETT: Well, Tony, I — (laughter) — we would like to. The odds are somewhat against us buying in any major country except the United States, if you’d name any specific one. I would hope in the next three years that we might get a chance to buy one or two companies of size. We’re always buying little companies that fit in with our present operations. Right now, MiTek has several possibilities outside the United States. But in terms of major businesses that Berkshire would buy, you know, if we get lucky, we’ll buy one or two in the next three or four years that’s based outside the United States. We’re trying to increase our chances of doing that. Whether it turns out to be China or India or Germany or the UK or Japan, who knows? There’s a lot of luck in that, just in terms of specific families thinking of us specifically. But we certainly wouldn’t rule it out. We’ve looked into developing an insurance company in some countries. Both India and China restrict the percentage ownership that Berkshire could have in any domestic insurance company.

They both have laws that would keep us — I know it’s 25 percent in China, and I think it’s 25 percent, but it may have been changed in the last year or so, in India. We do not probably want to go into a country to own 25 percent of a company like that. We would want the laws to allow us to do more than that to make it worth our while. But I hope we own something. You know, certainly at your age, you will see the day that Berkshire owns businesses — in my view, you’ll see the day — that they own — we own — businesses in both countries. Charlie?

CHARLIE MUNGER: Nothing to add.

27. Parents, spouses, and books are the best teachers

WARREN BUFFETT: OK. Number 9.

AUDIENCE MEMBER: Gentlemen, my name is Jim James (PH) from Minnesota, actually Minneapolis. And clearly you’ve inspired 38,000 people here today. Books have been written about you, not solely for your financial prowess, but because of the people you are. Could you share two or three influences on you — those kinds of people, educators, who have shaped your thinking on life and on investing? Thank you.

WARREN BUFFETT: Well, I think the biggest educator — certainly in my case — initially was my father. I think probably Charlie would say the same thing. And I think— it’s very, very, very important who you marry, and I’ve been lucky there, and those are great teachers. And, of course, I had Ben Graham. I had Dave Dodd. I’ve learned from all kinds of people who have written books over the years. I’ve just devoured those and picking up things here and there. Charlie learned a lot from Ben Franklin, obviously. (Laughter) Many people think Ben Franklin learned a lot from Charlie but — (laughter) — we both learned a few things from my grandfather at the grocery store. But your parents — I tell the students, you know, the most important job you have, you know, is being the teacher to your children. I mean, you’re the ultimate teacher. You’re this big — great big thing. You provide warmth and food and everything else, and they’re learning about the world, and they’re not going to change a lot of that when they get into graduate school or sometime.

So it’s — and you don’t get any rewind button. You don’t get to do it twice. So you have to do your best as a teacher, and you teach by what you do, not by what you say, with these young things. And by the time they’ve got to a place where they’re entering a formal school, they probably learned more from you than they’re ever going to learn from anybody else. Charlie?

CHARLIE MUNGER: Well, I would argue that differing people learn in differing ways. With me, I was put together by nature to learn from reading. If some guy’s talking to me, he’s telling me something I don’t know, I don’t want to know, I already know, or he’s doing it too slow or too fast. In reading, I can learn what I want at the speed that works. So, to me, reading is the — is what works for my nature. And to all of you who are at all like me, I say welcome. It’s a nice fraternity.

WARREN BUFFETT: You probably learn more from your father than you learned from all the reading you did, don’t you think? In terms of actually forming you?

CHARLIE MUNGER: Well, yes. And my father was the type that always did more than his share of the work and took more of his share of the risk. All that kind of example was, of course, very helpful, and you learn it better from a person close to you. But in terms of the conceptual stuff, I’d say I learned it from books. Now, those are fathers in a difference sense.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: The people who wrote the books.

WARREN BUFFETT: Yeah, well, one book, obviously, changed my whole financial life when I — you know, by happenstance, probably, I picked it up. I can’t even remember why I bought it back when I was in school. But if you just keep picking up enough books, you’ll find some — you’ll learn a lot. And I used to go through the Omaha Public Library and just go down the shelves. It’s kind of an inefficient way, maybe, of doing it, but I — if you read 20 books on a subject you’ve got an interest in, you’re going to learn one hell of a lot. You don’t know which one you’re going to learn it in, though. So I would take having — if you get the right parents, you’re very, very lucky, and it’s better than going to the right school or anything of the sort. And to get the right spouse, you’ve just doubled down.

28. Big institutional shareholders should take stand on CEO pay

WARREN BUFFETT: Number 10.

AUDIENCE MEMBER: Gentlemen, my name is Mark Slaybe (PH). I’m from Chicago. I probably am going to be one of the last guys speaking today or asking a question, so on behalf of 31,000 people, I’m going to thank you —

WARREN BUFFETT: Thank you.

AUDIENCE MEMBER: — for the respect and the common courtesy that you’ve exhibited to the shareholders today.

WARREN BUFFETT: Thank you. (Applause.)

AUDIENCE MEMBER: My question is this: I work for a fairly large computer company that’s a competitor of Mr. Gates up there. And I’m curious. As a common, ordinary person and a common shareholder, what can we do, 31,000-some odd folks here do, about the outrageous salaries, bonuses, perks, of these enormous corporations that we will never have a chance at, a shot at, you know, working with them and that amount of wealth? What would you advise us as common shareholders that we can do to get this country going the right way and get this issue going the right way? (Scattered applause)

WARREN BUFFETT: Well, I would say that, particularly on the compensation part, you can’t do much. But there are a relatively few people that could do a lot. If the half a dozen or so largest institutional owners took a position on extreme cases — I don’t advise them trying to go after each one — but when they see something egregious, if they would simply withhold their votes and issue a short statement as to why they’re doing it, that has an effect on — particularly on boards of directors. Big shots don’t like to be embarrassed. You know, they don’t — that gets their attention. The press is an enormous factor. Press is more of a factor in changing corporate behavior than regulations or Sarbanes-Oxley or that sort of thing. You want a good press. But the press needs the material, and material — the raw material — for that could be — I won’t name the organizations — but if you take the half a dozen largest investment organizations, I think it would have a lot of impact if they would — if they could get together on short statements when they felt pay was really egregious.

And I don’t know what you individually can do about that, and I don’t know how you create the incentives for the big institutions to do that. I mean, it doesn’t really do that much for them personally. I don’t think — I think the — a lot of the checklists that institutions use as determining whether they approve of corporate practices are asinine. I mean, they — you know, they get sort of the “issue du jure” and they get — and they get people recommending how they vote their proxies, which is kind of silly. I don’t know why they can’t make up their minds themselves as to what they think is proper or not proper. And Ben Graham, many years ago, bemoaned investors as a bunch of sheep. And with big institutions, I haven’t seen much difference. But it wouldn’t take many of them. It would take — just take a few of the biggest ones and the willingness to speak out. And the press would do the rest and boards would respond to that. But they’re not going to respond to you.

I mean, I have to be, you know, totally candid about that. A small shareholder can write the most persuasive arguments in the world, and I’ve been on the board where they’ve received those kind of letters. And basically they turn them over to the corporate secretary and say, “Take care of this,” or something of the sort. It takes real effective pressure to change behavior where the behavior is in the self-interest of that person. People do not give up self-interest easily. Charlie?

CHARLIE MUNGER: It’s an old question. In England, where they had a lot of class warfare, they at one time got the income taxes up to, like, 90 percent, so there just wasn’t any possibility of having a large earned income except, you know, by not reporting it. The tax rate got that high. That was quite counterproductive for England. And so you can get a politics of envy that sort of ruins the economic system because of the natural resentments and jealousies and so forth involved in excessive compensation. I think the people taking the compensation have a moral duty not to take it. I would argue that, when you rise high enough in American business, you get a moral duty to be underpaid, not to get all you can, but to actually be underpaid. If people are going to be generals and archbishops and everything else at low pay, I don’t see why leaders of great big enterprise can’t take less than the last dollar. (Applause.)

WARREN BUFFETT: Do you have any suggestions on how to implement those sentiments? (Laughs)

CHARLIE MUNGER: It’s very difficult.

WARREN BUFFETT: Yeah. Charlie has always said that envy is — strikes him — as the silliest of the seven deadly sins, because when you’re envious of somebody, you feel worse, and they don’t feel any — they feel fine. In fact, maybe they even feel better because you’re envious. So it’s such a counterproductive type of thing. So we — rule out as envy as part of your repertoire. And gluttony — (laughs) — I mean, that has some upside to it. (Laughter) Maybe temporary, may have some side effects, but, you know, there’s something to gluttony. And so lust, of course, I’ll let Charlie speak to. (Laughter)

29. It’s OK to buy pharmaceuticals as a group

WARREN BUFFETT: Number 11.

AUDIENCE MEMBER: Hello. I’m Clemmon Low (PH) from Toronto, Canada. I want to thank you for the wonderful meeting, and I think I’ve learned a lot more here in a few hours than many, many more hours during university days. My question is, you have invested in drug companies such as Johnson & Johnson and Sanofi. How do you evaluate the pipeline of these companies and know if their competitive advantage is, indeed, enduring?

WARREN BUFFETT: Well, that’s a good question. And unlike many businesses, when we invest in something like pharma, we don’t know the answer on the pipeline. It will be a different pipeline anyway five years from now. So we don’t know whether Pfizer or Merck, you know, or you name it — Johnson & Johnson — we don’t know which of those will come up with a blockbuster commercial drug three or four years from now, and we don’t try to assess it. What we do feel is, if we have a group of those companies bought at reasonable prices, that, overall, pharma will do well. Maybe not quite as well as they have in the past, but they’re doing something enormously important. They’re doing something that should offer chances for decent profits over time. And we do not pick one by one. I could not tell you what’s the number one potential in the pipeline of a J&J or Sanofi — whatever which one you want to name.

So I think in that area, actually, a group approach makes sense, which is not the way we would go at the banks or something of that sort. I do think if you buy pharma stocks at a reasonable multiple, a group of them, you know, you’ll probably do OK five or 10 years from now. I would not know how to pick the specific winner. Charlie?

CHARLIE MUNGER: Well, you speak from a position where you have a monopoly of our joint knowledge about pharmacology. (Laughter)

30. Why Berkshire sold PetroChina

WARREN BUFFETT: We will move on to number 12. (Laughter) He gets cranky later in the day. (Laughter) And we’re just about to the end, but we can take a couple more.

AUDIENCE MEMBER: Thank you. My name is Chow (PH). I’m coming from Woshi, China. Thank you, Mr. Buffett and Mr. Munger, for your unbiased opinion on China and Olympics. To support your (inaudible), we have a group of chairmen and CEOs from Chinese public companies to come to Omaha and try to learn from the best of how public companies should be run. (Applause.)

WARREN BUFFETT: Thank you.

AUDIENCE MEMBER: Quick question. We observed that you made a quick trade on PetroChina, not a typical buy and hold approach you do on investment. Our question is, when it’s come to selling PetroChina, what comes to your mind, and what suggestions you may have to these group of executives? There are positive forces in China, and we welcome everyone to our Olympics.

WARREN BUFFETT: Thank you. (Applause.) And I met Dr. Guo from the China Investment Corp here a few months ago. Was very impressed by him, had lunch with him here in Omaha. The PetroChina decision, just as we made it to buy it at a valuation overall of 35 to 40 billion when we thought it was worth a hundred billion, when oil was at $70 a barrel, roughly, 75, I figured the value was about 275 or 300 billion and we could sell it at that price. And we no longer felt it was undervalued compared to other oil companies, so we sold our stock. Now, incidentally, right after we sold it, it went up dramatically because, as you know, they issued A shares in in China, and it became very popular. And at one time, PetroChina became the most valuable company in the world, measured by market value, which would have come as enormous surprise to investors seven or eight years earlier. So they’ve done a terrific job. And if it went down to a price that we thought was a discount — a significant discount — to its valuation, we would buy PetroChina again.

The — in terms of — I’m not so sure we don’t have a lot to learn from the Chinese in terms of business currently, more than they have to learn from us. I’m not sure we would want some of our practices to spread to China. It’s a remarkable society, what’s going on there now. And I did go to Dalian not long ago, and I must have traveled for 45 minutes from the center of town out to our plant there. And I just saw, really, hundreds of plants that — factories that had developed in recent years. The economy is — the Chinese people are starting to realize their potential. I mean, what it amounted to is you had — for centuries — you had people of lots of ability but a system that did not unleash their potential. And now it’s starting to be unleashed, and that’s why you’re getting very substantial GDP growth per capita, and I think it will continue. I would just look for the best practices in American industry as you see them and copy them, and I would discard the rest. And I think it’s — you know, it’s how you learn about human behavior.

You try to — if you look at an effective individual, you try to figure out why they’re effective. You know, why is Don Keough, why are Tom Murphy — why are they so effective? Why do people want to be around them? Why are they leaders? Why do people love them? And you see certain human qualities, and you should copy those qualities. And when you see some guy that should have everything going for him and everybody in town hates him, you know, you want to make sure you don’t have any of those qualities. Well, I would do the same thing in terms of looking at businesses in this country, and try to look for what I admire and emulate it, and make sure that — try very hard — not to let the things that you find over here that are distasteful to you creep into your own system. Charlie?

CHARLIE MUNGER: Well, I hope you’ll go back to China and tell them that you met at least one fellow that really approves the Confucius emphasis on reverence for elderly males. (Laughter)

WARREN BUFFETT: I think you should dig yourself out of that by including females too, Charlie. (Laughs)

CHARLIE MUNGER: That wasn’t Confucius’s idea.

WARREN BUFFETT: Oh, OK. No reason why you can’t modify it. (Laughs)

31. Future hopes for Berkshire

WARREN BUFFETT: OK. We’ll have one more, and then we’ll take a break and come back for the business meeting in a few minutes. Number 1.

AUDIENCE MEMBER: Mr. Buffett and Mr. Munger, my name is Cynthia Beeman (PH), and I’m from Atherton, California. This is my question: what is your fondest hope for Berkshire Hathaway moving forward in time?

WARREN BUFFETT: Well, in a general way, I hope for two things — obviously, I hope for decent performance, and I hope that the culture we have is maintained, which is both shareholderoriented and manager-oriented, and that we are regarding as the best home in the world for large, wonderful, family businesses. And I think the performance and those two goals will be intertwined, in a way. And I not only hope, but I fully expect, that what we’ve tried to build into Berkshire lives far beyond, you know, my tenure as CEO. And I think it will because, A, we’ve got the right candidates to succeed me. And, beyond that, we have a board, we have a bunch of managers, that have all seen how well the system works. So I think that we have about as strong a culture as you could find in this country among American businesses. And if that’s continued, as I’m really sure it will be for a long, long, long time, I think we will get decent results. We won’t get great results, because you can’t get them from our size base.

But that’s my hope — that people 20 years from now, if they have a fine business they’ve spent a couple of generations building, and they immediately think — if they have to sell it for some reason — they think Berkshire Hathaway is the place where we want the ownership of this business and we want — as managers, we want to continue working at that company for the rest of their lives. And if we can achieve that, we’ll have something fine for shareholders, and we’ll have something fine for managers and owners of those businesses we buy. Charlie?

CHARLIE MUNGER: Yeah. I would say that I would like to see Berkshire even more deserved to be an exemplar, and I would like to see it have more actual influence on changes in other corporations. I think there are things that have happened here that will be useful to others.

WARREN BUFFETT: We’d also like it to have the oldest living managers, but that’s a minor point. (Applause.)

WARREN BUFFETT: Thank you. Thank you. Thank you. Thanks.

32. Break before formal business meeting

WARREN BUFFETT: The — now what we’ll do is we’ll just break for five or so minutes, and then we’ll reconvene and have the formal business meeting. After that, at 4 o’clock, for the international visitors, those from outside of North America, we will — Charlie and I — will meet with them personally. And I thank you all for coming. I hope you come back next year and bring your friends. Thank you. (Applause)

33. Formal business meeting

WARREN BUFFETT: — appropriate questions you may have concerning their firm’s audit or the accounts at Berkshire. Mr. Forrest Krutter, our secretary at Berkshire, he 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 representative at the 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 5, 2008, being the record date for this meeting, there 1,081,013 shares of Class A Berkshire Hathaway common stock outstanding with each share entitled to one vote on motions considered at the meeting, and 14,033,343 shares of Class B Berkshire Hathaway common stock outstanding with each share entitled to 1/200th of one vote on motions considered at the meeting. Of that number, 883,428 Class A shares and 10,921,716 Class B shares are represented at this meeting by proxies returned through Thursday evening, May 1.

WARREN BUFFETT: Thank you. That number represents a quorum, and we’ll therefore directly proceed with the meeting. First order of business 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 the shareholders be dispensed with and the minutes be approved.

WARREN BUFFETT: Do I hear a second? Barely, I hear a second. The motion has been moved and seconded. Are there any comments or questions? We will vote on this motion by voice vote. All those in favor say “aye.”

VOICES: Aye.

WARREN BUFFETT: Opposed? The motion is carried.

34. Election of board of directors

WARREN BUFFETT: First item of business is to elect directors. If a shareholder is present and 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 shareholders are present who 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 aisles who will furnish a ballot to you. Would 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.

WALTER SCOTT: I move that Warren Buffett, Charles Munger, Howard Buffett, Susan Decker, William Gates, David Gottesman, Charlotte Guyman, Don Keough, Tom Murphy, Ron Olson, and Walter Scott be elected as directors.

WARREN BUFFETT: Is there a second to the motion? Somebody second the motion.

VOICE: Second.

WARREN BUFFETT: OK. It has been moved and seconded that Warren Buffett, Charles Munger, Howard Buffett, Susan Decker, William Gates, David Gottesman, Charlotte Guyman, Don Keough, Thomas Murphy, Ronald Olson, Walter Scott be elected as directors. Are there any other nomination? Is there any discussion? The nominations are ready to be voted 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 a ballot on the election of directors voting the proxies in accordance with the instructions they’ve received. Miss Amick, when you’re ready, you may give your report.

BECKI AMICK: My report is ready. The ballot of the proxy holders in response to proxies that were received through last Thursday evening cast not less than 935,155 votes for each nominee. That number far exceeds a 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, Susan Decker, William Gates, David Gottesman, Charlotte Guyman, Donald Keogh, Tom Murphy, Ronald Olson, Walter Scott have been elected as directors.

35. 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 this meeting be adjourned.

WARREN BUFFETT: Is there a second?

VOICES: Second.

WARREN BUFFETT: A 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.