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Charlie Munger on Berkshire's Future, Taxes, and the Debt Ceiling

The Wesco Financial shareholders' meeting was canceled this year, ending an event hundreds flocked to in the past: a three-hour unscripted rant by Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) Vice Chairman Charlie Munger. (I've covered the event in the past, here and here.)

While the meeting was canned, Munger has been on an interview blitz lately. The latest was done with CNBC. A few topics from the interview that caught my attention.

Asked if he was confident in Berkshire's future now that David Sokol is out of the succession race, Munger responds:

"Oh my God yes. I have said over and over again that the Mungers are going to hold their Berkshire stock for decades after Warren is dead. If I think Berkshire can live without Warren, it can certainly live without Sokol.

"I don't know a company in America that I feel better about succession than I do about Berkshire. A), The subsidiaries have enormous autonomy, so who comes into the head office matters less. B), We need fewer people to think about succession because we've concentrated so much power at the top. And C), we've got a wonderful group of people that have risen in this 250,000-person-strong system. In my opinion it is no problem.

"Will a successor do as well as Warren relative to the rest of the world? Of course not. Warren is like to business what Newton is to physics. He'll be hard to top. But is a successor going to do very credibly? The answer is yes.

"And Warren had to do very well from a poor beginning. A successor has enormous advantages Warren didn't have, because Berkshire is so strong and there's so much talent and so much business momentum. I'm not just worried at all."

That last part might be the most important. The impact Buffett's eventual passing will have on Berkshire holdings like GEICO, Coca-Cola (NYSE: KO  ) , Burlington Northern, or Procter & Gamble (NYSE: PG  ) is basically zero. All of these are independently run organizations with customers who have probably never heard of Buffett. While Buffett essentially is Berkshire, very little of the company's year-to-year income relies on him. Investors should worry more about the passing of someone like Ajit Jain, who runs Berkshire's reinsurance division. Berkshire's earnings power will almost certainly fall when Ajit moves on. (Thankfully, he's still relatively young).

There's an argument that Berkshire's stock will be forever dinged once Buffett goes -- the end of the "Buffett premium." But this may not be as big a problem as some think. Berkshire doesn't trade at nearly the price-to-book multiple it did in years past, nor is the multiple out of line with many competitors. Buffett's mortality, most likely, is already being priced in. The Buffett premium is hard to find.

Back to Munger, with a word on the current tax system:

"I think the idea that the hedge fund manager gets lower taxes than the taxi driver or the physics professor is insane. The legislators who leave that policy in place are derelict in their duties to be rational and fair. There are plenty of them in both political parties. It's totally outrageous.

"Hedge funds treat the money that's really paid to him for management [as a deferred capital gain.] It's the equivalent of doing your work [points to journalist]. You pay ordinary income taxes, and they pay 15%. Or even less than 15%, which is not quite understood! There's a lot of untaxed appreciation that accretes to them with no taxes at all.

"The situation is crazy. Yet these people make political contributions and they wrap themselves in the flag of enterprise, and we end up with hedge fund managers who have what you and I would call ordinary income taxed way lower than the income of a taxi driver. It's totally outrageous. And everybody with any sense knows this. Just some business school professors and economists who are too dimwitted to understand it. Most ordinary people get it.

"I think it's so outrageous that it will eventually be changed."

Here's how this works. Hedge fund managers invests other people's money. The manager gets a percentage of the gains as compensation, typically 20%. Under current rules, that income is treated as a capital gain for the manager, even though it was earned for performing a job, and the manager faced no downside risk if he produced losses -- this is someone else's money, after all.

Not only are capital gains taxed at a lower rate than ordinary income, but the tax isn't triggered until the hedge fund manager cashes out, often years down the road, if ever. As tax policy journalist David Cay Johnston noted last month, John Paulson, the hedge fund manager who perfectly shorted the housing market and then just as perfectly rode the recovery back up, earned $9 billion in client fees over the past few years, but hasn't yet paid a penny of taxes on it.

Taxing capital gains at a lower rate than ordinary income may have merit. Determining what counts as a capital gain is the issue here. Munger himself is sitting on billions of dollars of untaxed capital gains, but the gains are tied to an investment originally made with his own money, where he faced personal loss had things turned south. That's a real capital gain. Relatedly, no one disputes that income hedge fund managers earn from investing their own money in their own funds should be treated as legitimate capital gains.

Here's Munger again, now on the debt ceiling:                                

"Both parties are competing to see which one can be the most stupid. They do crazy things like have hold-up polices about debt ceilings, and they justify it by saying 'Well, I had to do it to advance my version of the Holy Grail concept.'

"But the United States issues the main reserve currency of the world, and we have the world half blowing up here and there. Is it really responsible to use the debt ceiling as a bargaining chip in the ordinary legislation of Congress? I would say no."

This raises the question of why the U.S. even has a debt ceiling. No other major nation has one. The popular argument is that a debt ceiling prevents the Treasury from engaging in out-of-control spending. But this is short on logic: The Treasury doesn't spend money. It simply pays the bills Congress racks up. If overspending is the issue, that's what Congress should be debating -- not whether it should tie the hands of the bank that pays for its spending. And this isn't about one party reining in the other. As former Controller General David Walker rightly noted last summer, "There's no party of fiscal responsibility based on actual track records."

A few more short Mungerisms:

Could Berkshire have prevented the Sokol ordeal with better compliance? "If you want a lot more compliance, go to Lehman Brothers. They had a big compliance department."

Why was Berkshire's first press release on Sokol so timid? "Some guy actually complained we didn't have enough anger. Well, that guy was demented. Who thinks his decisions are better if he's angry?"

On success and integrity: "Costco (Nasdaq: COST  ) is full of trustworthy people. It's one of the reasons it does so well."

Fool contributor Morgan Housel owns shares of Berkshire Hathaway and Procter & Gamble. Berkshire Hathaway, Costco Wholesale, and Coca-Cola are Motley Fool Inside Value recommendations. Berkshire Hathaway and Costco Wholesale are Motley Fool Stock Advisor selections. Coca-Cola and Procter & Gamble are Motley Fool Income Investor selections. The Fool owns shares of Berkshire Hathaway, Coca-Cola, and Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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  • Report this Comment On May 16, 2011, at 6:36 PM, fredgei wrote:

    "This raises the question of why the U.S. even has a debt ceiling. No other major nation has one. The popular argument is that a debt ceiling prevents the Treasury from engaging in out-of-control spending. But this is short on logic: The Treasury doesn't spend money. It simply pays the bills Congress racks up."

    But the debt ceiling allows Congresscritters to vote on both sides of the issue. And that's the important point!

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