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Berkshire Hathaway Could Be Facing a Double-Whammy

Warren Buffett is kind of a big deal. But is his company too big to fail?

Recent reports that the Fed is considering naming Berkshire Hathaway  (NYSE: BRK-A  ) (NYSE: BRK-B  ) , a "Systemically Important Financial Institution," the technical term for "too big to fail," come after a number of highly publicized accidents, fires, and explosions involving crude oil shipped by rail. Berkshire's subsidiary BNSF Railways is the largest shipper of oil by rail in North America, and increased standards and tighter regulations could impact the company's bottom line. 

The question is, how much could these two potential threats of government regulation hurt Berkshire's bottom line -- and CEO Warren Buffett's ability to reinvest the company's cash? Should investors should look to competitor American International Group (NYSE: AIG  ) , with its substantial discount to book value, and business less complicated by dozens of other business units? 

Too big to fail not a fallback position
Buffett used those words in his letter to shareholders several years ago, and considering Berkshire was a paragon of strength during the recession, loaning billions to Bank of America and Goldman Sachs, among others, during the lowest moments stemming from the financial crisis, it seems absurd that Berkshire could even be considered a risk. 

But when a company has insurance holdings the size of Berkshire's, it's not folly for the Fed to at least take a hard look. After all, Peter Lynch said it best: "Go for a business that any idiot can run -- because sooner or later, any idiot is probably going to run it." 

BNSF hauls more oil than any railway in North America. Source: Todd Murray.

Buffett's success has largely been about managing risk, but eventually, Buffett will be gone. The risk is that when the next inevitable financial crisis occurs, Berkshire sans-Buffett may not be run in the same conservative manner, and the lack of oversight could wreak havoc. Just because Buffett built Berkshire into a distinctly diverse business doesn't mean its massive insurance holdings need any less oversight than, say, AIG's. 

Benmosche agrees
"They say big companies that are in the insurance business should be regulated, but I guess somehow they're not. They're pretty big, the last time I looked," said AIG CEO Robert Benmosche in 2013. Since AIG and Berkshire compete in the reinsurance business, it's no surprise he would want to see Berkshire have more hoops to jump through.

Benmosche has done a remarkable job turning AIG into a lean and competitive business again, largely selling off assets outside of its core business, and using the proceeds, in addition to strong profits, to pay off the Fed loans that kept the company afloat over the recession. 

While not holding the diverse stock positions and dozens of non-insurance businesses that Berkshire does, AIG is a compelling investment in its own right, because the market is still applying a heavy discount to a company that's nothing like the bloated behemoth of 2008. While the turnaround in the business is essentially complete, Mr. Market hasn't yet caught up to its value, assigning a heavily discounted price to book value (P/B) ratio of 0.74, nearly half the company's historical multiple under former CEO Hank Greenberg. 

What kind of blown might BNSF be dealt?
BNSF generated a whopping $3.4 billion in earnings in 2012, almost one-quarter of Berkshire's total. But onerous regulations that cut into that earnings power could further limit Buffett's ability to invest, especially if the FSOC requires Berkshire to keep more cash on hand. 

The NTSB's recommendations to the Department of Transportation, which oversees the nations railways, include forcing trains hauling crude to avoid populated areas altogether, and to increase the number of audits of trains and equipment used. This would add significant costs, while also reducing the total number of deliveries BNSF is able to make if each shipment takes longer to complete. 

Feeling nervous? Source: Freddie Peña.

Worst case unlikely; good news about BNSF
The worst-case scenario would be the Fed labelling Berkshire a SIFI and increasing capital requirements, while at the same time, DOT regulations hurt BNSF's earnings power. Combined, these two events could severely limit Buffett's ability to invest Berkshire's profits, or worse -- force selling of assets. But Berkshire has historically been risk-averse, so a SIFI labeling wouldn't likely change much, if anything, about how the company manages capital today. 

BNSF will probably have more regulation to deal with, but the market for oil and gas via rail is only going to expand. New safety measures will only serve the industry better, and the expansion in domestic shipments should more than make up for additional expense and longer routes. 

Still an amazing company with lots of life after Buffett
The reality is, this isn't about Buffett's Berkshire: It's about what may come years down the road. The good news is, Buffett has made efforts to prepare the company for his eventual departure. Executives like his investment managers Ted Weschler, 52, and Todd Combs, 42, and 29-year-old Tracy Britt Cool, chairperson of four of Berkshire's subsidiaries and maybe Buffett's closest assistant, will play important roles in the post-Buffett era. 

For long-term shareholders, it's Buffett's long-term focus and planning that will make it more likely that Berkshire remains a solid investment well into the future, whatever regulators throw its way. 

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Read/Post Comments (6) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 29, 2014, at 4:13 PM, commoncents33 wrote:

    If the Fed feels the need to change ANYTHING at Berkshire, that will confirm that our nation has gone completely off the tracks.

    Berkshire is more Fort Knox than Fort Knox. If anything, Berkshire should be teaching the government how to run ITS ship. For the disastrous fiscal situation of the Federal government is the ultimate is systemic risk. Who will bail them out when they fail?

    And this is all not theoretical. Berkshire has PROVEN their mettle in the past decade, easily handling the 9-11 attacks and Katrina and Sandy, all without breaking a sweat...and by being almost like the government in bailing-out failures during the 2008-9 financial crisis.

    That this is even up for discussion is nauseating.

  • Report this Comment On January 30, 2014, at 2:29 PM, 45ACPbullseye wrote:

    Nice article Jason! Best, Bill

  • Report this Comment On January 30, 2014, at 7:05 PM, TMFVelvetHammer wrote:

    Thanks Bill!

  • Report this Comment On January 30, 2014, at 8:31 PM, Brian2003 wrote:

    Any wonder why Buffett is such a big fan of Obama's? So long as Obama continues to block the Keystone pipeline, Buffett continues to rack up billions ($3.4B in 2013) and billions of dollars. Anyone want to bet on the backroom deals or long term payback Obama gets?

  • Report this Comment On January 30, 2014, at 11:51 PM, TMFVelvetHammer wrote:

    >>Any wonder why Buffett is such a big fan of Obama's? So long as Obama continues to block the Keystone pipeline, Buffett continues to rack up billions ($3.4B in 2013) and billions of dollars. Anyone want to bet on the backroom deals or long term payback Obama gets?<<

    That's just dumb. Buffett has five decades of evidence that his integrity is more important to him than money. He wouldn't have given 90% of his wealth away if that were the case. And he's 83 years old. His legacy, you can promise, is very instant to him. Not a few billion bucks.

    Besides, keystone would only affect a small part of BNSF's oil shipments. Much of the oil BNSF moves is being taken to east coast and west coast markets, which gain premium prices versus the gulf coast refineries which Keystone XL will supply. Chances are, this will remain true, and BNSF will keep shipping oil east and west. Not south.

    People have been passing that lie around for about a year now. Don't believe everything you hear just because it rings true. Obama's a democrat, which means he'll favor going slow on anything that's environmentally questionable.

    Buffett has been relatively centrist politically for years. He didn't turn that way when Obama showed up. Know your facts.

  • Report this Comment On February 03, 2014, at 7:53 PM, Mykiemon wrote:


    Here here!

    (That's Brit for "I couldn't agree more")

    Well said.


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Jason Hall

Born and raised in the Deep South of Georgia, Jason now calls Southern California home. A Fool since 2006, he began contributing to in 2012. Trying to invest better? Like learning about companies with great (or really bad) stories? Jason can usually be found there, cutting through the noise and trying to get to the heart of the story.

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