To the Shareholders of Berkshire Hathaway Inc.:
We will never become dependent on the kindness of strangers.
Too-big-to-fail is not a fallback
position at Berkshire. Instead, we will always arrange our affairs so that any requirements for cash
we may conceivably have will be dwarfed by our own liquidity. Moreover, that liquidity will be
constantly refreshed by a gusher of earnings from our many and diverse businesses.
When the financial system went into cardiac arrest in September 2008, Berkshire was a supplier
of liquidity and capital to the system, not a supplicant. At the very peak of the crisis, we poured
$15.5 billion into a business world that could otherwise look only to the federal government for
help. Of that, $9 billion went to bolster capital at three highly-regarded and previously-secure
American businesses that needed – without delay – our tangible vote of confidence. The remaining
$6.5 billion satisfied our commitment to help fund the purchase of Wrigley, a deal that was
completed without pause while, elsewhere, panic reigned.
We pay a steep price to maintain our premier financial strength. The $20 billion-plus of cashequivalent
assets that we customarily hold is earning a pittance at present.
But we sleep well.
...
We make no attempt to woo Wall Street.
Investors who buy and sell based upon media or analyst
commentary are not for us. Instead we want partners who join us at Berkshire because they wish
to make a long-term investment in a business they themselves understand and because it’s one that
follows policies with which they concur. If Charlie and I were to go into a small venture with a
few partners, we would seek individuals in sync with us, knowing that common goals and a shared
destiny make for a happy business “marriage” between owners and managers. Scaling up to giant
size doesn’t change that truth.
...
An old Wall Street joke gets close to our experience:
Customer: Thanks for putting me in XYZ stock at 5. I hear it’s up to 18.
Broker: Yes, and that’s just the beginning. In fact, the company is doing so well now,
that it’s an even better buy at 18 than it was when you made your purchase.
Customer: Damn, I knew I should have waited.
...
Ajit writes billion-dollar limits – and then keeps every dime of the risk instead of laying it off with
other insurers. Three years ago, he took over huge liabilities from Lloyds, allowing it to clean up its relationship
with 27,972 participants (“names”) who had written problem-ridden policies that at one point threatened the
survival of this 322-year-old institution. The premium for that single contract was $7.1 billion. During 2009, he
negotiated a life reinsurance contract that could produce $50 billion of premium for us over the next 50 or so
years.
If Charlie, I and Ajit are ever in a sinking boat – and you can only save one of us – swim to Ajit.
...
And now a painful confession: Last year your chairman closed the book on a very expensive business
fiasco entirely of his own making.
For many years I had struggled to think of side products that we could offer our millions of loyal
GEICO customers. Unfortunately, I finally succeeded, coming up with a brilliant insight that we should market
our own credit card. I reasoned that GEICO policyholders were likely to be good credit risks and, assuming we
offered an attractive card, would likely favor us with their business. We got business all right – but of the wrong
type.
Our pre-tax losses from credit-card operations came to about $6.3 million before I finally woke up. We
then sold our $98 million portfolio of troubled receivables for 55¢ on the dollar, losing an additional $44 million.
GEICO’s managers, it should be emphasized, were never enthusiastic about my idea. They warned me
that instead of getting the cream of GEICO’s customers we would get the – – – – – well, let’s call it the
non-cream. I subtly indicated that I was older and wiser.
I was just older.
...
In earlier days, Charlie and I shunned capital-intensive businesses such as public utilities. Indeed, the
best businesses by far for owners continue to be those that have high returns on capital and that require little
incremental investment to grow. We are fortunate to own a number of such businesses, and we would love to buy
more. Anticipating, however, that Berkshire will generate ever-increasing amounts of cash, we are today quite
willing to enter businesses that regularly require large capital expenditures. We expect only that these businesses
have reasonable expectations of earning decent returns on the incremental sums they invest. If our expectations
are met – and we believe that they will be – Berkshire’s ever-growing collection of good to great businesses
should produce above-average, though certainly not spectacular, returns in the decades ahead.
...
Our largest operation in this sector is Clayton Homes, the country’s leading producer of modular and
manufactured homes. Clayton was not always number one: A decade ago the three leading manufacturers were
Fleetwood, Champion and Oakwood, which together accounted for 44% of the output of the industry.
All have
since gone bankrupt. Total industry output, meanwhile, has fallen from 382,000 units in 1999 to 60,000 units in
2009.
The industry is in shambles for two reasons, the first of which must be lived with if the U.S. economy
is to recover. This reason concerns U.S. housing starts (including apartment units).
In 2009, starts were 554,000,
by far the lowest number in the 50 years for which we have data. Paradoxically, this is good news.
People thought it was good news a few years back when housing starts – the supply side of the picture
– were running about two million annually. But household formations – the demand side – only amounted to
about 1.2 million. After a few years of such imbalances, the country unsurprisingly ended up with far too many
houses.
There were three ways to cure this overhang: (1) blow up a lot of houses, a tactic similar to the
destruction of autos that occurred with the “cash-for-clunkers” program; (2) speed up household formations by,
say, encouraging teenagers to cohabitate, a program not likely to suffer from a lack of volunteers or; (3) reduce
new housing starts to a number far below the rate of household formations.
Our country has wisely selected the third option, which means that within a year or so residential
housing problems should largely be behind us, the exceptions being only high-value houses and those in certain
localities where overbuilding was particularly egregious. Prices will remain far below “bubble” levels, of course,
but for every seller (or lender) hurt by this there will be a buyer who benefits. Indeed, many families that couldn’t
afford to buy an appropriate home a few years ago now find it well within their means because the bubble burst.
...
We told you last year that very unusual conditions then existed in the corporate and municipal bond
markets and that these securities were ridiculously cheap relative to U.S. Treasuries. We backed this view with
some purchases, but I should have done far more. Big opportunities come infrequently. When it’s raining gold,
reach for a bucket, not a thimble.
...
We have long invested in derivatives contracts that Charlie and I think are mispriced, just as we try to
invest in mispriced stocks and bonds. Indeed, we first reported to you that we held such contracts in early 1998.
The dangers that derivatives pose for both participants and society – dangers of which we’ve long warned, and
that can be dynamite – arise when these contracts lead to leverage and/or counterparty risk that is extreme. At
Berkshire nothing like that has occurred – nor will it.
It’s my job to keep Berkshire far away from such problems. Charlie and I believe that a CEO must not
delegate risk control. It’s simply too important. At Berkshire, I both initiate and monitor every derivatives
contract on our books, with the exception of operations-related contracts at a few of our subsidiaries, such as
MidAmerican, and the minor runoff contracts at General Re. If Berkshire ever gets in trouble, it will be my fault.
It will not be because of misjudgments made by a Risk Committee or Chief Risk Officer.
...
In my view a board of directors of a huge financial institution is derelict if it does not insist that its
CEO bear full responsibility for risk control. If he’s incapable of handling that job, he should look for other
employment. And if he fails at it – with the government thereupon required to step in with funds or guarantees –
the financial consequences for him and his board should be severe.
It has not been shareholders who have botched the operations of some of our country’s largest financial
institutions. Yet they have borne the burden, with 90% or more of the value of their holdings wiped out in most
cases of failure. Collectively, they have lost more than $500 billion in just the four largest financial fiascos of the
last two years. To say these owners have been “bailed-out” is to make a mockery of the term.
The CEOs and directors of the failed companies, however, have largely gone unscathed. Their fortunes may
have been diminished by the disasters they oversaw, but they still live in grand style. It is the behavior of these
CEOs and directors that needs to be changed: If their institutions and the country are harmed by their
recklessness, they should pay a heavy price – one not reimbursable by the companies they’ve damaged nor by
insurance.
CEOs and, in many cases, directors have long benefitted from oversized financial carrots; some
meaningful sticks now need to be part of their employment picture as well.
...I can’t resist telling you a true story from long ago. We owned stock in a large well-run bank that for
decades had been statutorily prevented from acquisitions. Eventually, the law was changed and our bank
immediately began looking for possible purchases. Its managers – fine people and able bankers – not
unexpectedly began to behave like teenage boys who had just discovered girls.
They soon focused on a much smaller bank, also well-run and having similar financial characteristics
in such areas as return on equity, interest margin, loan quality, etc. Our bank sold at a modest price (that’s why
we had bought into it), hovering near book value and possessing a very low price/earnings ratio. Alongside,
though, the small-bank owner was being wooed by other large banks in the state and was holding out for a price
close to three times book value. Moreover, he wanted stock, not cash.
Naturally, our fellows caved in and agreed to this value-destroying deal. “We need to show that we are
in the hunt. Besides, it’s only a small deal,” they said, as if only major harm to shareholders would have been a
legitimate reason for holding back. Charlie’s reaction at the time: “Are we supposed to applaud because the dog
that fouls our lawn is a Chihuahua rather than a Saint Bernard?”The seller of the smaller bank – no fool – then delivered one final demand in his negotiations. “After
the merger,” he in effect said, perhaps using words that were phrased more diplomatically than these,
“I’m going
to be a large shareholder of your bank, and it will represent a huge portion of my net worth. You have to promise
me, therefore, that you’ll never again do a deal this dumb.”
Yes, the merger went through. The owner of the small bank became richer, we became poorer, and the
managers of the big bank – newly bigger – lived happily ever after
...
Last year we changed our method of determining what questions would be asked at the meeting and
received many dozens of letters applauding the new arrangement. We will therefore again have the same three
financial journalists lead the question-and-answer period, asking Charlie and me questions that shareholders have
submitted to them by e-mail.
Neither Charlie nor I will get so much as a clue about the questions to be asked. We know the
journalists will pick some tough ones and that’s the way we like it.
...
At 86 and 79, Charlie and I remain lucky beyond our dreams. We were born in America; had terrific
parents who saw that we got good educations; have enjoyed wonderful families and great health; and came
equipped with a “business” gene that allows us to prosper in a manner hugely disproportionate to that
experienced by many people who contribute as much or more to our society’s well-being. Moreover, we have
long had jobs that we love, in which we are helped in countless ways by talented and cheerful associates. Indeed,
over the years, our work has become ever more fascinating; no wonder we tap-dance to work.
If pushed, we
would gladly pay substantial sums to have our jobs (but don’t tell the Comp Committee).
(emphasis added)
http://www.berkshirehathaway.com/letters/2009ltr.pdf
