Over the weekend, Warren Buffett posted his annual letter to the shareholders of Berkshire Hathaway. You can read it here (PDF).
The 20-page letter is, as always, partly a recap of the Buffett philosophy: only buy businesses you understand, keep plenty of cash on hand, run companies for long-term return and not short-term stock-price gain. Buffett talks about some of his mistakes (GEICO credit cards were a dud, but he only has himself to blame), explains in detail the logic of one of Berkshire’s portfolio companies (this year, the newly acquired Burlington Northern Santa Fe railroad), declares his undying love for Ajit Jain (who expertly runs a slice of Berkshire’s formidable insurance operation), and tosses in a few folksy aphorisms (one isn’t allowed to write a piece about Warren Buffett without using the word “folksy” so I thought I’d get it out of the way early).
This year’s letter also makes two bold proclamations. First, that within a year or so housing-market woes will be a thing of the past. Second, that directors and CEOs of bailed-out financial firms are derelict and need to be punished.
The housing-market call comes amid a discussion of Berkshire portfolio company Clayton Homes, which sells manufactured houses. Elsewhere in his annual report, Buffett takes financial journalists to task for not reporting what he says in full and proper context, so hang with me here through some long pull-quotes.
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.
There are plenty of people out there saying similar things, but this is Buffett talking now, so ears are perking up.
The other really memorable piece of the shareholder letter comes right after Buffett explains how he takes personal responsibility for Berkshire’s derivatives contracts, since risk management is too important a task to leave to anyone except the CEO. He writes:
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.
The billionaire everyman lives on.