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Subject:  WARREN BUFFETT AS HIMSELF 2/6/09 Date:  2/8/2009  11:37 AM
Author:  mhirschey Number:  150924 of 220849

I just returned from Omaha where Cathy Shenoy, director of our applied portfolio management program, and I took KU Finance Scholars and Finance Club officers (27 students in all) to Berkshire Hathaway, Inc. headquarters for a question and answer session with Warren Buffett. In addition to KU, students from Creighton University, Emory University, the University of South Dakota, Penn State University, and the University of Texas were represented. Berkshire is planning 8 such events this year for 48 schools and roughly 1,300 students. The itinerary is a two-hour Q&A with Warren at “World Headquarters,” lunch at a local restaurant (in our case, Piccolo Pete’s Steak House) was followed by pictures. Warren bought lunch.

Anyone interested in the quality of top business students from around the country would be delighted with what transpired. The students were uniformly respectful, courteous, and energized. They asked thoughtful questions that deserved the well-considered responses offered by Warren. In professional business attire, the students looked and acted the part of up and coming business executives. Students asked questions that they themselves had conceived. This was definitely a student-led endeavor. In fact, no faculty at all accompanied students from UT or Penn State. Penn State students not only secured their invitation, they arranged the trip and paid their own expenses. KU student expenses were covered by Scott Jones (Prairie Wind Capital), a generous former student.

In roughly chronological order, the two-hour discussion proceeded as follows:

1. Buffett sees things in the financial markets that he’s never seen before, nor did he ever expect to see them. For example, Berkshire recently bought a three-month T-bill that involved a small amount of negative interest. Buffett joked that the mattresses sold by Nebraska Furniture Mart were a better place to put your money. Presently there is a bubble in U.S. Treasury securities. Credit spreads have gone from far too narrow a couple of years ago to far too wide today. Money can be made shorting Treasuries and going long corporate bonds, provided you can play out your hand. Excessive amounts of leverage used by hedge funds have resulted in enormous losses from sensible bets because players could not play out their hands. Buffett told a silly joke about how tough things were in the financial sector. “I know off a Wall Street investment banker who got no bonus this year. He came home and told his wife that they’d have to really cut back. “If you could learn to cook,” he said, “we could lay off the kitchen staff.” She replied, “If you could learn how to make love, we could lay off the gardener too.””

2. Buffett has bet against the U.S. dollar from time to time, but would never bet against the United States. Human welfare in the United States has grown by seven fold during the last century thanks to our rule of law and meritocracy. Central planning and class-based societies based upon inherited wealth are far inferior. With the present 7.6% unemployment rate, the United States is under producing but will come out of the current downturn just fine. Warren expressed admiration for the Chinese manufacturer behind the “Build Your Own Dreams” initiative (

3. Derivatives are “weapons of mass destruction” (WMDs). In a now familiar refrain, Buffett said once again that derivatives are financial WMDs. Financial derivatives create big problems when executives get paid annual bonuses based on their current valuation of long-tail derivatives. When Berkshire bought GeneralRe they had 100-year derivatives! Berkshire presently holds lots of financial derivative contracts, Buffett said, but Berkshire always holds the financial collateral. Counter party risk is huge. Buffett likened the counter-party risk tied to financial derivatives to the counter-party risk with venereal disease. “The problem isn’t just who you’re sleeping with, it’s also all the other people that person is sleeping with. Before you know it, the disease spreads and the whole emergency ward is filled up.” Buffett has long regarded real WMDs as the biggest threat faced by society today. With modern knowledge, capability, and deliverability, any maladjusted crackpot can do enormous damage. In the days of the cave man, they threw rocks. Now they have nuclear capability. Berkshire is fortified to withstand simultaneous nuclear attacks in New York and Washington, DC.

4. “If you were just coming out of school today, would you look for stock-market bargains in the financial sector?” “You don’t get rich by making sector bets,” Buffett replied, “but there are lots of bargains in the financial sector right now. Not just stocks, but bonds and some other financial securities are also cheap. Who would have predicted that Bank of America (BAC) would fall from the 50s to less than 4?” All young people should be cautious about the dangers of debt. He also admonished the students to develop the right kinds of habits, “The chains of habit are too lightly felt until they are too heavy to be broken.” In a joking reference to being hard of hearing, Buffett said he recently told Charlie Munger: “Charlie, we should buy GE at 11.” No response. Moving closer, Buffett said once again, “Charlie, we should buy GE at 11.” Again, no response. Finally, Buffett moved up close and shouted in Charlie’s ear. “Charlie, we should buy GE at 11!” Charlie turned to him and said, “For the third time, Warren, YES.” (Note: Berkshire has disclosed big positions in U.S. Bancorp and Wells Fargo, and small positions in GE and BAC).

5. “Berkshire Hathaway has made big insurance investments. Is Berkshire apt to get into health insurance in a big way?” “No,” Buffett quickly replied. He does not want to get into types of insurance where buyers may not understand what coverage they have or can expect. Harley Davidson bonds should do well. “It’s a wonderful business when customers are willing to tattoo your name on themselves,” Buffett said.

6. “What mistakes did Treasury Secretary Henry Paulson make prior to and during the current credit crisis?” Buffett said that his friend Hank Paulson did almost an impossible job under the most trying of circumstances. With 535 senators and members of congress, all with different incentives and agendas, it is impossible to satisfy everyone. Moreover, when one approach to dealing with the crisis got criticized or shot down, the problem escalated, and the necessary remedy grew. Hank Paulson, Fed chairman Ben Bernanke and Treasury Secretary Timothy Geithner are all real public servants who do their best for the country at great personal sacrifice. During the election campaign, Buffett told candidate Barack Obama that he had good news and bad news to relate about the economy. “Give me the good news first,” Barack replied. “Well, the good news is that the economy is so bad that you’ll get elected. The bad news is that the economy will be worse on Inauguration Day.” Barack paused and quipped: “Is it too late to throw the election?”

7. “Will the stimulus package work?” Buffett said that monetary policy has been exhausted, and classical Keynesian fiscal policy stimulus is all that’s left. Proposed fiscal policies are much better than sitting back and doing nothing. However, the power of fiscal stimulus is limited. When FDR took over, for example, he had an unlimited ability to get things passed quickly. While the U.S. unemployment rate fell from 25 percent to 9 percent by 1939, the U.S. economy never fully recovered from the Great Depression until World War II. Today, we could have the Federal Government put everybody to work making capital equipment, or battle ships, and take them out into the ocean and sink them, but that would not be as beneficial as current plans to stimulate the production of capital goods and services that will be used over time. Still, Buffett admonished, we have to be careful. “When it comes to economic policy, you never do just one one thing at a time.” (Note: Meanwhile, Janet Yellen, president of the San Francisco Federal Reserve Bank and a voting member of the policy-setting Federal Open Market Committee in 2009 told reporters Friday that the Fed needed to fight back against the notion that its liquidity efforts would inevitably lead to higher inflation and higher interest rates, terming the notion "ludicrous."

8. Ovarian lottery: The students loved Buffett’s “ovarian lottery” allegory. Suppose a genie confronted you with the following opportunity. Take a large barrel filled with 6.5 billion tickets, each representing a single birth outcome. Assume the genie selected 100 tickets at random from the barrel and offered to switch your own birth outcome for the best of those 100 tickets. Only about 50 would be of above average intelligence, f