There were several questions regarding the credit market problems of the past year. The responses ranged from making fun of the folly wrought by so-called "financial innovation" to several lengthy comments specifically regarding what happened with auction rate securities a couple of months ago. (These are debt securities who
se coupon payments are periodically determined at auction by investors.)
Buffett gave an example of a city utility whose municipal bonds traded with the coupon yielding 3.5% one week, 8.0% at the next week's auction, and 10% the week after that, only to fall back to 3.5% after the auction rate market started operating somewhat normally again. Both Buffett and Munger noted that this huge dislocation in the credit markets was a once-in-50-year event and made no sense at all. The fearless pair running Berkshire acted quickly and resolutely to benefit from the madness, and advised investors in the audience to also act quickly and resolutely such when large, rare opportunities happen to arise.
Regarding Berkshire's start-up municipal bond unit, Buffett noted that this business has, inside the space of a single quarter, gone from a standing start to having a leading market share, stealing business away from the likes of Ambac at a very rapid rate. This is a fantastic example of Berkshire using the competitive advantage that its financial strength confers.
In the first quarter, Berkshire's new bond insurance unit wrote about $400 million in premium volume with 278 transactions, and all the counterparties sought Berkshire out as the insurer of choice. Plus, as a not-so-subtle slight to the competitors in this space, Buffett noted that all the bonds now insured by Berkshire (with its "real" AAA credit rating) carried lower yields (better for the issuer) than bonds insured by the other insurance companies, such as Ambac, that are holding on to their AAA ratings by their fingernails. Here at Morningstar, we've long postulated that Berkshire would use its copious liquidity to benefit from the credit market problems, and this is perhaps "exhibit A" proving the point.
Buffett and Munger also commented on the topic of peak oil. This is the argument over whether the world is soon going to reach a peak in oil production before production flattens and eventually falls. They both seemed to agree that we were indeed close approaching a time of peak oil production, though Munger was the more vocal of the two. He noted that all energy resources on the globe--oil, natural gas, coal, uranium--are finite resources and will eventually run out. Therefore, the sun and the wind are essentially the only truly renewable alternative energy resources, and they will eventually have to be tapped in a large way.
Putting Munger on the spot concerning peak oil, Buffett asked him to give an "over/under" on what he thought oil production would be in 25 years. In typical Munger fashion, he gave a terse response that perfectly explained his opinion: "down."
Regarding Bear Stearns, Buffett and Munger both agreed that the Fed saving the investment bank from declaring bankruptcy was the right thing to do. In their opinion, allowing Bear Stearns to fail would have created a "spectacle of unprecedented proportions" that probably would have taken down another bank or two, inflicting great damage on the financial system.
Despite their opinion about the Bear Stearns rescue, the pair did not mince words when talking about all the greed, over-reaching, and over-leveraging that created an institution that was "too big to fail." I couldn't count how many times Munger uttered words like "crazy" and "demented" in describing what is common today on Wall Street.
The U.S. dollar was also a common topic of conversation, and Buffett reiterated his bearish stance about its future direction relative to other currencies. Berkshire continues to be very interested in purchasing businesses based outside the U.S., and not hedging the currency exposure those businesses bring. In fact, Buffett is planning a trip to Europe shortly to try to increase the awareness among business owners there of Berkshire as a potential home for their life's work.
The topic of future stock market returns also came up, and here the pair again shared a less-than-optimistic projection. They did not pretend to know where the market was going to go in the short term, but they most certainly had opinions about long-term returns. They agreed most fervently that future market returns were going to be less attractive than those achieved in the past. Moreover, in a hint concerning the hurdle rates currently being used at Berkshire, they also noted that they would be happy with a 10% return from stocks, but might settle for slightly less.
To end on a lighter note, one youngster from Chicago asked whether Buffett would be interested in buying the Chicago Cubs, an American baseball team, a business that is currently on the block. Although the idea had clearly been pitched to Buffett before, he pointed out that there is a significant "psychic income" to owning a sports team related to the fame it brought to any specific owner. In other words, it is highly unlikely the price is going to be right for Buffett to buy the team. And as Buffett pointed out earlier in the meeting, he does not do anything regardless of price.
