Berkshire Hathaway Annual Meeting 2009 - Derivatives, Financial Crisis, Newspapers & Inflation

Buffett on 2008 financial crisis anomaly: 'If instead of buying US Treasury bills that matured in four months and paid us five million and ninety dollars - instead had bought the Nervous Nelly mattress and had put their money under the mattress they would have been ninety dollars better off at the end of the year, at the end of four months, than by buying Treasury bills. If the US Treasury had just sold five trillion of these they could have made an easy 90 million dollars and Tim Geithner could have put the money under a Nervous Nelly mattress and we all would have been better off. Negative yields on US Treasury bills are really an extraordinary thing. You got less - got less for your money from the US Treasury than you got from sticking it under a mattress. I'm not sure you'll see that again in your lifetime but it's been a very extraordinary year.' Shows extreme flight to safety during 2008 crisis - investors willing to PAY for safety of T-bills.

Carol Loomis question on derivatives destroying equity/capital. Buffett: 'I referred to them on a macro basis in the 2002 report as being financial weapons of mass destruction but I also said in that report that we use them in our own business regularly when we think they're mispriced. We think our shareholders are intelligent enough that if we explain the transactions as we try to do in the annual report and explain why we think we will make money - there's no guarantee - but our expectancy is that we will make money. As long as we explain them, the financial consequences to our shareholders far outweigh any accounting consequences.' On equity put options: 'We have received 4.9 billion dollars roughly and we hold that money. Originally the terms were 15 to 20 years so we have the use of 4.9 billion for 15 to 20 years and then markets have to be lower at that time than they were at inception. I personally think the odds are extremely good that on the equity put options we will make money.' On high yield CDS: 'I think we will probably lose money before figuring the value of the money we've held. I told you a year ago I thought we would make money on those but we have run into far more bankruptcies in the last year than normal. We've in effect had a financial hurricane. We insure against natural hurricanes and we insure against financial hurricane.'

On rating agencies: Buffett: 'Charlie and I don't pay any attention to ratings. We don't believe in outsourcing investment decisions. If we buy a bond the rating is immaterial to us except to the extent that if we think it's rated more poorly than it should it may help us buy it at attractive price. But we do not think that the people at Moody's or Standard Poor's or Fitch or anyplace else should be telling us the credit rating of a company. We figure that out for ourselves and sometimes we disagree with the market in a major way and we made some money that way.' Munger: 'The rating agencies being good at doing mathematical calculations eagerly sought stupid assumptions that enabled them to do clever mathematics. It's an example of being too smart for your own good. There's an old saying: to a man with a hammer every problem looks pretty much like a nail. And that's what happened in the rating agencies.' Buffett: 'The interesting thing about a lot of those triple-A's is the people that created them ended up owning a lot of them. So they believe their own bologna themselves. Everybody - the belief was enormous. So you've had these people stirring up the Kool-Aid and then they drank it themselves and they paid a big penalty for it. I don't think it was - I think it was stupidity and the fact that everybody else was doing it.' Key point: 'The one reason you can't give at Berkshire as far as I'm concerned for any action is that everybody else is doing it. If that's the best you can come up with, something's wrong.'

California shareholder asks about residential real estate. Buffett: 'We don't know what real estate is going to do. Very hard to tell. From what I'm seeing and I do see a lot of data - there are many markets within California, Stockton will be different than San Francisco - but in the last few months you've seen a real pickup in activity although at much lower prices. I think you've seen something in the medium to lower price houses - and medium means different thing in California than Nebraska - but maybe $750,000 and under houses, you've seen a real pickup in activity, many more bidders. You haven't seen a bounce back in price. Prices are down significantly and varies by area. But it looks as if - you had a foreclosure moratorium for a while so you get into distortions because of that - but what it looks like looking at our real estate brokerage data and we have the largest real estate brokerage firm in Southern California (Orange County, Los Angeles County, San Diego County) - Prudential of California that's owned by Mid-America - I would say something close to stability at these much reduced prices in the medium to lower group. If you've got a five million dollar house or three million dollar house that still looks like a very erratic market with not a lot of activity. But in the lower levels there's plenty of activity now, houses are moving. Interest rates are down so much easier to make payments. The mortgages being put on the books every day in California are much better than the mix you had a few years earlier. So it's improving.'

Kentucky shareholder notes 2007 to 2008: investments down 13%, earnings down 4%, but market value down 31%. Buffett: 'You put your finger on something. We think obviously the investments are worth what they're carried for or we wouldn't own them. In fact we think they're worth more money than they're carried for at any given time because we think on balance they're under-priced. We define our earning power - we leave out insurance underwriting profit or loss on theory that if it breaks even will give us float which we will invest. On balance I actually think insurance probably will produce some underwriting profit so I think we even understate a little bit. We think the earning power of those businesses was not as good last year as normal, won't be as good this year as normal, but we think those are pretty good businesses overall. I think it's perfectly reasonable to look at Berkshire as sum of two parts: a lot of liquid marketable securities fairly priced or maybe even undervalued, and a lot of earning power which we are going to try and increase over time. If you look at it that way you would come to conclusion that Berkshire was cheaper in relation to its intrinsic value at end of 2008 than end of 2007. But you would also come to conclusion that was true of most securities. The whole level of securities - every stock is affected by what every other stock sells for. If value of ABC stock goes down, XYZ is worth less. If you can buy stocks at 8 times earnings good companies or 9 times earnings, it reduces the value of Berkshire as opposed to when stocks were selling at 18 or 20 times earnings. Everything is affected by everything else in the financial world.'

Munger response to valuation question: 'I would argue that last year was a bad year for a float business. It was naturally going to make the owner of the float appear briefly to be at a disadvantage. But long term having a large float which you're getting at a cost of less than zero is going to be a big advantage. And I wouldn't get too excited about the fact that the stock goes down. I happen to know there was one buyer there who rather inartistically bought about 10,000 shares when Berkshire was driven to its absolute peak. How much significance does that have in the big scheme of things? Over the long term what matters are things like this: Our casualty insurance business is probably the best big casualty insurance business in the world. Our utility subsidiary - well if there's a better one I don't know it. And if I had to bet on one carbide cutting tool business in the world I'd bet on Iscar against any other comer. And I could go down the list a long way. I think those things are going to matter greatly over the long term. And if you think that it's easy to get in that kind of a position - the kind of position that Berkshire occupies - you are living in a different world from the one I inhabit.' Classic Munger: focus on long-term competitive positioning, not short-term stock price volatility.

Young person asks how inflation will affect his generation. Buffett: 'We will have inflation over time. Paul Volcker got very upset three weeks ago when he read that a majority of the Federal Open Market Committee had sort of targeted two percent inflation as the number. Volcker who came in when inflation was raging and saw the problems of stopping it when it got a momentum of its own said "two percent sounds great but in a generation it cuts away purchasing power by 50%." He was right. Once you start thinking about a couple percent you are on something of a slippery slope. We are following policies in this country now to stimulate things which are bound to have some inflationary consequences. To the extent that we borrow money from rest of world, it would be very human on the part of politicians in the future to decide that they would rather pay the rest of the world back in dollars that are worth far less than the dollars they borrowed. It's the classic way of reducing the impact and cost of external debt and we're building up a lot of external debt.' On who pays: 'I always find it interesting when politicians now talk about using the taxpayers money to do this and that and how taxpayers are paying bonuses at AIG. We haven't raised taxes at all in this country. Taxpayers are paying nothing beyond what they were paying couple years ago. Federal revenues this year which were close to 2.6 trillion couple years ago maybe more like 2.3 trillion. So we are taking less money from taxpayers. The people who are really paying for the things we're doing now will probably be the people who are buying fixed dollar investments much of it from US government and who will find the purchasing power when they go to redeem those investments to be far less. You might say that the AIG bonuses - probably the Chinese are the people that are ultimately paying the most in terms of loss of purchasing power they will have with their holdings of government bonds many years down the road. But it sounds better to say the taxpayer than to say the Chinese are paying for it.'

Continuing inflation answer: 'So you will see plenty of inflation. Now the best protection against inflation is your own earning power. If you're the best teacher, if you're the best surgeon, if you're the best lawyer - whatever it may be - you will command a given part of other people's production of goods and services no matter what the currency is, whether it's seashells or Reichsmarks or dollars. So your own earning power is the best by far. If you're the best journalist whatever it may be, you will get your share of the national economic pie regardless of the value of whatever the currency may be measured against some earlier standard. The second best protection is a wonderful business. If you own the Coca-Cola trademark company, you will get a given portion of people's labor 20 years from now and 50 years from now for your product and it doesn't make any difference what's happened to the price level generally because people will give up three minutes of labor whatever it may be to enjoy 12 ounces of a product they like. Those are the great assets: your own earning power first and then the earning power of a wonderful business that does not require heavy capital investment. If it requires heavy capital investment you get killed in inflation. With those guidelines I would tell you the best thing to do is invest in yourself.' Munger: 'Yes the young man should become a brain surgeon and invest in Coca-Cola instead of government bonds.'

Andrew asks about newspaper business, Washington Post stock decline, and whether would buy more newspapers. Buffett: 'I would say in today's environment - it's an evolutionary development but current economic environment has accentuated the problems of newspapers but it is not the basic cause. Newspapers are to the American public as a whole - Charlie and I read five a day, Charlie probably reads five a day, we'll never give them up - but we'll also be the last guys reading a newspaper while having a landline phone by our side. So you don't want to judge consumer preferences by what we do.' Shows self-awareness that Buffett/Munger habits don't reflect broader consumer trends. Newspapers facing structural, not cyclical, decline.