Below are my notes from the 50th Wesco Annual meeting. I've transcribed my hand written notes and tried my best to keep the spirit of Mr. Munger's thoughts, even if I couldn't recall the exact phrasing he used.
The meeting started off with Mr. Munger conducting the formal part of the annual meeting. Afterward he had some prepared remarks.
"We're going to copy the Berkshire format, but do a more extreme version. I'm going to answer a bunch of questions of myself and then answer them." The crowd was amused.
Q: How serious is the economic mess?
A: This is really serious and the worst we've seen since the 1930's, which caused the rise of Adolph Hitler. You can't predict how upset people can behave in times of great turmoil.
Q: What caused the mess?
A: As most of you know, I believe in lollapalooza effects. It's usually a confluence of many factors that cause these types of events.
#1 There were absurd and perverse practices in consumer credit. There was a swelling of consumer credit. People who knew enough pushed way too much of it onto people who didn't always know better. Lenders knew people had multiple credit cards and they didn't care. Now that banks are poorer they are sticking it to the people who need credit. I believe if you do immoral things, you'll ultimately get what's coming to you.
#2 Mortgage lenders were the scum of the earth. They were flim flaming minorities and others who were vulnerable. The second mortgage field was the worst but the first mortgages were bad too.
#3 Wall street went crazy. Anything short of armed robbery was rationalized. No one cared if you were immoral as long as you made money.
#4 Regulatory body also contributed to this mess. There were two camps of regulators:
One wanted to put people into homes, even if they couldn't afford them. This fueled the craziness at Fannie Mae and Freddie Mac.
The other wanted to deregulate banks, like they did with restaurants.
Wall Street was making 9% off of selling sludge.
#5 Leverage and CDS meant you could bet that anyone could go broke. Sometimes the person who owned the CDs would actually help contribute to the downfall of the person who got into trouble. He mentioned about how you can't do that in the insurance field but those wise words weren't followed by Wall Street. Mark to model allowed both sides to book profits. There was no clearance system for these trades. The accounting was all phony. CDS market was in the trillions of dollars. People like Greenspan helped make it respectable. It wasn't like free enterprise in restaurants. Instead, it was like armed robbery.
At one point every bank deposit looked like it was in trouble. Luckily the government stepped in and we had to save some of the worst banks and offenders to make it safe for everyone else. I was particularly impressed by the decision to take over (into receivership) Fannie and Freddie. They quickly lowered mortgage rates and it has worked.
Banks are tougher. Usually no one hears about what the regulators are going to do until they've done it. I like that process best. Put me down as dubious as to the contests (stress tests on banks). I do give the treasury department a lot of credit.
Warren and I think Wells Fargo is a much better entity because their cost to borrow is lower than others. If I were stress testing, I would give them a clear pass. They might get unfairly hampered by a one-size-fits-all system but if it's effective, so be it.
Q: What are the long term consequences of all this on Wesco?
A: Almost nothing. Our businesses are gaining market share and we're well financed.
Q: What government responses have been inappropriate?
A: Ethanol. They didn't count all the costs of producing it. Cheap food is strategically important for all countries. Luckily it seems it is going out. Cap and Trade is unlikely to work. The Chinese are spewing out most of the hydrocarbons and they aren't going to stop because we don't want the sea levels to rise a bit. It's an international situation so this is massively stupid.
Q: What should you care about?
A: Using up hydro carbons so fast should be a big concern. We like and need fertilizer.
Q: So how can we solve the energy problem?
A: We need to use the energy from the sun. We need an efficient power grid and we need to switch over to battery powered automobiles. Al Gore doesn't know how to think but Freeman Dyson does. The Chinese are dying young because of poor air quality caused by brown coal. They are highly motivated to gallop to a leadership position in the production of solar power. I don't know whether mirrors or photovoltaics are the better way to go. I have a hunch that photovoltaics are the better way. It just seems like such a simple approach. It's very possible we could get costs down by 50%. We need stimulus anyway and this is a good use of that money.
Israel is interesting. Ethan Wertheimer from Iscar said that while in drought, half of Israel's water is coming from the sea. Arabs have huge deserts. With endless power from the sun and the ability to get fresh water from the sea they can do much better.
Building this power grid in the U.S. would do much good. Let the utility companies figure it out. I'm not a big fan of one-offs, where each person hooks up their own solar collection device to their garage. Utilities are much more efficient and they can do time shifting etc.
I didn't think lithium batteries would work. But I was told they are very good and we can recycle them. We have lots of lithium in the sea, so that's not a problem. The electric car at Berkshire has one problem. If you step on the accelerator too hard, you spin the tires. Those electric motors produce lots of torque. That's why they were used in locomotives.
Perhaps this would make it easier for the Arabs and the Israelis to live together. Extreme poverty in Arab countries is very bad for us all.
I think we can all handle it if the seas rise a little bit. Look at Holland. With today's technology and engineering that's not a big threat. Unfortunately some people always want to be the town crier.
We have unemployed people and building an electric grid would be a very good thing.
When the Chinese want to do something, they go and do it. India has too much due process. They got that from England and it's the wrong thing. Sacred cows are screwing up traffic. We've amended plenty of religious ideas in the past and it can be done here too.
Q: How fast will economic recovery come?
A: Japan put the full force of the government behind the problem driving interest rates to 0% and had plenty of stimulus spending. They got stasis. It would be very bad for U.S. to have 0% GDP growth over 10 years. Japan is an interesting and scary example. Their stimulus was useless. They spent the money filling potholes three times but it didn't do anything to increase their productivity.
Keep in mind that I never took an economics class. I'm self taught on these things. I'm not apologizing. I look at things my own way.
Q: What do I think about current stock prices?
A: As Warren (Buffett) said, he's had his best performance in a bad year for stocks. I'm agnostic to what the market does. I'm willing to buy at current prices and to hold for a long period. Coke and Wells Fargo are good investments. Just don't expect miracles. You need to set your expectations correctly. I tried to teach my kids that if someone promises you a really good return and he gets a good commission from the deal, it's useless information.
I'm pretty well invested right now. You're entitled to know because you're cultists. You can evaluate whether you think I'm right or wrong. I'm in my 86th year now.
We're very lucky we have a wonderful thing to do with the stimulus. I've been quoted 7-8% power losses when transmitting energy over long distances. Iowa gets 20% of its electricity from wind now. All kinds of things can be done.
Q: What kind of re-regulation should there be for financials?
A: Big financials that are too big to fail shouldn't be anything but a boring business. They were conservative when the partners owned them. No system should give any bright young man $8 billion to play with. They should take away everything that is not boring. They can keep the rest, like issuance of new securities and stock broking.
You shouldn't be able to go crazy with massive leverage. We don't need the options exchanges, everything worked fine without them, in the past. The world worked fine without CDS's. Hedge funds should be allowed maybe 2X leverage, if they're investing for highly competent investors.
No one deserves a ransom for ballooning a balance sheet. What social purpose does it serve? People in New York will scream at that of course.
I would run the country more like Singapore. In the 1950's and 1960's the world worked fine. Obama said he would reduce the power of New York and I admire him for it. However, I don't think he'll change it as much as I would. My suggestions would have a constrictive effect at first, but it would be worth it in the long run.
Q: What about Wesco vs. Berkshire?
A: Berkshire stock is a better deal at current prices because you people are cultists. If I were buying, I would buy Berkshire. Berkshire is getting to be a big name, Wesco is just an anomaly.
Well we're done with the Socratic solitaire. Now we'll take some questions from the audience. (He started with people from the press first. I didn't get everyone's name or publication)
Q: What would you do if you were Secretary of the Treasury?
A: I agree with Paulson. He started with a toxic asset plan and changed his mind because he realized it wasn't enough. The current people are able and terribly constrained because of politics. For this reason, I never wanted to go into politics.
Q: (Buck Hartzell - The Motley Fool) You often talk about the power of incentives. If you were President what would you be incentivizing? How do you feel about the handling of the Big three automobile manufacturers?
A: I would incentivize the building of the power grid. As far as the auto companies are concerned, in the world I'm imagining Toyota has a problem. If Toyota has a problem, Detroit is really in trouble. I would combine the big three into a single company and throw out all their liabilities. Let them pick and choose what employees will stay on. That plan has about a 40% chance of working. The current plan has a 0% chance. At one time Rochester New York has Xerox and Kodak. Those two companies have faded yet Rochester has survived. They've got good health care and houses are cheap. It's the way of the world that some places will decline while others places will prosper. Detroit has been behind and one step slow, for several years now. If I can die cheerfully some places can handle deteriorating while others prosper. It's okay and it's natural.
Q: A question about outperforming the market.
A: I have no system to teach everyone else. To double the market's averages over a long time is pretty hard.
Q: How can investors avoid unpleasant surprises and downturns like we had this past year?
A: There's no system to avoid this unpleasantness. If you never suffer, you haven't lived a life that's right.
Q: (Paul Larson from Morningstar) Can you recommend any books this year?
A: Outliers by Malcom Gladwell. I tend not to read the self-help investment books. It's like the soap operas, I know all the plots.
Questions from the floor
Q: What about inflation? Where will you see inflation first and how do you hedge against it?
A: Let's start with my life. I remember $.05 hamburgers, $.02 stamps and I remember being paid $.25 per hour. Though the dollar has depreciated, it didn't ruin the investment climate for me. It isn't easy. Of course there will be inflation. Once people could vote and elect their officials there was going to be inflation.
Q: How is Berkshire preparing for inflation?
A: We're aware of it. We were buying corporate bonds at 8-10%. In a world where treasuries are yielding 3%, that's not too bad.
Q: You've spoken out against excessive executive compensation and the behavior on Wall Street. How could you invest in Goldman Sachs?
A: We believe their merits outweighed their defects.
Q: What impact do you think the commercial real estate market will have on GE Capital?
A: They will lose some money.
Q: Why is Coke's current management more successful than the previous one?
A: The current CEO is likely to be viewed as gifted.
Q: How will Wells Fargo's business model and prospects change as a result of new regulations?
A: They are pretty well located. They have bright prospects. We may have more regulations on credit cards. When you change rates on people it infuriates them. Banks should behave better. Those changes are good things.
Q: Can you teach executive leadership?
A: Like dogs, some are more teachable than others. Overtime capitalism tends to weed out the worst ones. It's the like the professional golf tour. That's a good system.
Q: What qualities do you look for in your leaders?
A: I need trustworthy people with good judgment. Warren likes to say you don't need a high I.Q. and that's true. But, if Warren had a 130 I.Q. Berkshire wouldn't look anything like it does today. Crazy overconfidence is what does people in. Financial salesmen know how to push all the right buttons. I recently looked at a REIT. There's no way that anyone could read that. They sold it though because there was a big commission in it.
Q: What do you think of India vs. China as investments?
A: I think Wan Chun Fu (BYD CEO in audience) wants to make a contribution to civilization and the world. I wish I could stay longer and watch. I think he will succeed because he deserves to succeed.
Q: How do you balance short term and long term decisions? I've started a business and would take any customer I can find.
A: I'm not sure Charlie understood this question. He was having trouble with the sound system. He said, I don't back start-ups, it's just too hard. I found a way that is easier for me. Meaning they don't invest in ideas, they prefer to invest in proven leaders that not only have a business plan, but are profitable.
Q: Are there limits to growth?
A: Sure, growth is finite.
Q: You bet on railroads and volumes are down 20% plus much of their cargo is coal. What are your thoughts?
A: Right. If we stop using coal it would be tough on railroads. They have a competitive advantage over trucking and I think it's full proof.
Q: If you were in charge of the new electrical grid, what would you do? How long would spend planning?
A: Of course you do the engineering first. I don't know how long it would take to design it. The Chinese are really fast from design to build. He mentioned one project that began building in only 7 months.
Q: (Whitney Tilson) The newspapers reported you weren't optimistic about the current investment climate, coming out of the Berkshire meeting. I interpreted your opinion as being just the opposite. Can you compare this period to past investing climates?
A: (I don't think Charlie understood this question. He did kind of answer it earlier by saying he was most fully invested). He said, sure we have a great utility business. If a better grid project comes along Berkshire will be involved. Our two managers are excellent and they get along with regulators. We'll be bigger in a few years. We are willing to do big deals.
Q: Any fresh ideas on human judgment? (The last chapter of Poor Charlie's Almanack Munger talks extensively about the psychological root of many of our poor decisions).
A: Like sunshine, human misjudgments will always be part of the world. It will always look crazy afterward. Berkshire will, on average, have less of these errors than others.
Q: The best chapter in Outliers
A: The best chapter was on a guy who had an I.Q. of 200 who was a failure. If you can't learn from that then I wouldn't bet on you.
Q: How much oil will we produce going forward? Will it be enough to meet our demand?
A: We will produce less of it. We are near peak (oil production) or past it. It will get more and more expensive. The world will adapt to higher prices of oil because it has to. If oil went to $200 a barrel America wouldn't cave in. It would change behavior but we would adapt.
Q: From an economic standpoint, what questions should we be considering?
A: If someone asked what the chances are for the use of atomic weapons in the next 30 years, it certainly is possible. I visited Japan a few years ago and it's still a civilized place with 0% GDP growth. I believe mono cultures (homogeneous) get along better than groups with different groups and religions.
Municipal bonds won't always have great ratings like they've had in the past. Politicians would gladly throw losses to insurers instead of their voters. I believe Berkshire should be selective in pursuing this type of business.
Q: At the Berkshire meeting Warren said that Geico spends $800 million per year on advertising and they need to spend $100 million just to maintain their share. Should I consider that $100 million maintenance capital expenditure?
A: Yes, $100 million is maintenance.
Q: Have you read Snowball? What did you think of it?
A: It was a pretty good book. To write a book that big about a single person is quite a thing. She talked to a lot of different people and she slipped up on a few things. She also made a lot of money off of that book.
Q: What do you think of reverse mortgages?
A: I'm leery of them. I'm not saying they shouldn't exist. I am saying that I'm always leery of something where big commissions are involved in selling things to older people.
Q: Berkshire evolved into an institution of learning. How will Berkshire impact society?
A: The Berkshire model is so different from other companies. A lot of people think we're nuts. Ben Franklin suggested that officers of the U.S. shouldn't be paid. They should serve because they want to serve and be wealthy enough to do it. I love that idea. There aren't many like that. We don't pay our board of directors a lot. They don't need the director's fee. Corporations would be better if all directors weren't paid. The idea is not spreading like wildfire, but I believe it. I think corporations are important. Wal-Mart could very well be more important than Harvard. It's a fun and interesting job to a director, why should they be paid? Franklin didn't get anywhere with it and either have I. If you like the idea why don't you carry the torch?
Q: Will inflation rival that of the 1970's?
A: Well recognizing the problem is one thing. It's important to keep your expectations within reason. Problems are hard. If you bought real estate recently on the expectation of inflation you got burned. There are negative things involved with TIPS (Treasury Inflation Protected Securities). You need to adapt your expectations to what you can expect. Mentioned about his son's friend to stretched to hard for returns and lost everything. Some of the best salesman can't wait to cheat people to get a second pair of alligator shoes. It requires a lot of discipline to live a proper life.
Q: What about deflation?
A: Each area is different. In Omaha I would buy a house. In other areas there is more difficult to come. Pasadena is a pretty good place. Prices are high but politicians are pretty honest. If I wanted a house for my family I would buy one. I would probably buy it out of foreclosure though.
Q: Question about why the Chinese struggled long ago.
A: They had a dumb emperor and a Confucius bureaucracy. They were leaders in 1300's or so and lost it. This time they will likely get their share.
Q: What do you see in China?
A: I like that they respect older males (he laughs). Wan Chan Fu got $300,000 from his cousin to start his business. I like their work ethic. I like Confucianism. I like leaders that are engineers. It's my kind of communism. They are a nuclear power. We need to get along with them and they need to get along with us.
Q: Is A.I.G. still under pricing risk?
A: These are sad days for A.I.G. Those types of headlines don't help when you're trying to sell insurance. It could happen to Berkshire if we made a bunch of bad decisions. It's easy to fall backward, especially when children are raised in wealthy homes. We never want to deny our children anything. We would be better off if kids had more discipline. It's in our nature to pass on our wealth. Look at Egypt and England they passed on the baton.
Q: What do you think about CAP M and Finance professors? Will the future of finance teaching take a turn for the better after all we've been through on Wall Street and asset allocation?
A: I don't think much of Finance professors. They try to turn it into Physics. You get a lot of false precision. They all believe in diversification. They want you to buy a little bit of a lot of things that you don't know anything about. We buy a few things that we know something about.
Q: How do you judge trustworthiness?
A: It's tough. There is no formula. You need to know about business and about human nature.
Q: What do you think about corporate law?
A: At big firms there's too much paperwork and not enough common sense. One of my biggest successes in business was to fire most of my customers. We were selling transformers. Some transfer agents never allowed us to make any money. So we figured out who it was and fired them. The business shrunk but it became a very good business. Some places teach you to rook suppliers but I don't think it works.
Q: What do you think about newspapers?
A: The daily paper will likely perish. I think it's unfortunate. Perhaps they will survive in some limited way but the microeconomics are tough to overcome.
Q: What do you think of California tax free bonds?
A: I believe our credit rating is the second worst, just behind Mississippi. Our legislature is stuck with only the nuts on both sides. The good guys don't always win.
Q: How will the trade deficit resolve itself?
A: Strange things happen. Who would have thought Margaret Thatcher would come in and do the things she did? Warren is more concerned about this than I am. China is prospering by taking our paper. They are getting good at making stuff, like batteries.