Buffett – I was wrong on the Irish banks in a very big way.

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Buffett on his investments in banks during the financial crisis – 

Berkshire’s annual meeting 2009.

AUDIENCE MEMBER: OK. Hello Warren, Charlie. Felton Jenkins from Savannah, Georgia, a longtime shareholder, and partner.

Just want to make a quick comment about something that was a big deal the last couple of years about PacifiCorp. There was some controversy.

But I’m glad that PacifiCorp has agreed to work with the Native Americans and fishing communities on the West Coast to remove the uneconomic and harmful dams on the Klamath River.

So I want to encourage PacifiCorp management to move quickly, close the deal, and open the river soon. But thanks for their improved efforts over the last year.

My question is, you mentioned Wells Fargo got to $9. And that was a great deal, it looks like, at that price.

But what about Washington Mutual, AIG, Wachovia, Citigroup, Fannie Mae, even some Irish banks that I think you were involved with?

Those went through $9. And probably a lot of people thought they were still good deals or mispriced at $9.

And now you’ve got very expensive toilet paper, essentially, out of those stock certificates. So I mean, how would you know on the way down?

And looking at something like Bank of America, that was on the 13F sometime recently, what’s a likely outcome for a Bank of America and how would you analyze what might happen?

Thanks.

WARREN BUFFETT: Well, there’s some you can’t analyze. And on the Irish banks, I couldn’t have been more wrong.

But it isn’t a matter of whether they go through $9 or anything like that. It’s really what their business model is and what kind of competitive advantage they have.

I would say that Wells, among the large banks, has, by far, the best competitive position, you know, of any — of the really large banks in the country.

And essentially, if you look at the four largest, they each have somewhat different models. But the model of Wells is more different from the other three than any one of the other three would be from the remaining group. But I was wrong on the Irish banks in a very big way. I simply didn’t understand. And I should’ve understood.

It was available for me to understand, the incredible exposure they’d got into in more land development-type loans — not property loans, in terms of completed properties — but all kinds of land development loans.

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It was extraordinary. For a country with 4 and a fraction million people, you know, they had money lent for developing properties, homes, that would extend just forever in the future.

It was the terrible mistake by me. Nobody lied to me, nobody gave me any bad information. I just plain wasn’t paying attention. The — If you talk about the WaMus — I don’t want to go through all the names on them, because it’s specific to some companies.

But there were a lot of signs that they were doing things that a highly leveraged institution shouldn’t be doing. And that could cause trouble if this model of ever-rising housing prices turned out to be a false model.

You can get in a lot of trouble with leverage. I mean, it’s — you start creating $20 of assets, or something like that. You know, for every dollar of equity, you better be right.

And some of those big institutions did some very — what, in retrospect, for certain here — were foolish things, which, if they hadn’t been so highly leveraged, would not have hit them as badly.

And I would say most of them, if you read the 10-Ks and 10-Qs and did some checking, you could spot differences in them. Certainly, you can spot —

There’s no comparison if you take Wells Fargo versus a WaMu or something like that. I mean, you don’t have to have an advanced level of sophistication about banking to compare those two.

They’re two different kinds of businesses. It’s like comparing a copper producer whose costs are $2.50 a pound with a copper producer whose costs are $1 a pound.

Those are two different kinds of businesses. One is going to go broke at a buck-fifty a pound. And the other one’s going to still be doing fine.

And banking has real difference in it. But people don’t — they don’t seem to look at them. The figures are available. And — but they don’t seem to look at them very carefully.

When Wells reported the other day, they have an item of expense of over $600 million in a quarter for the amortization of core deposits. That is not a real expense.

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I mean, the core deposit figure will be up over time. And they are entitled under the tax law to put up, I don’t know, $15 billion or so, and they get to amortize that, which is an advantage.

But I didn’t see one newspaper article or any commentator that mentioned that that $600 million charges are in there, which is entirely different than looking at any other bank. But it just — it goes unnoticed.

So the figures are there. And the information’s there. And I think with Freddy and Fannie, for example, I think it was pretty clear what was going to happen.

Now, the interesting thing is, the government was telling them to go out and raise some more money for investors. And if those investors had put the money in, it would’ve been gone. It was already gone, actually, within a month or two, so —. We had calls on that, people trying to — investment bankers — trying to place billions of dollars with us on something, on those two institutions. And you just could take one look at them and you could tell they were in big, big trouble.

You do have to know a little bit about — you have to know something about banking and what’s going on in the various kinds of lending and everything.

And I would say that generally speaking, for people that don’t spend a lot of time on their investments, they’re going to have trouble separating financial institutions.

I think it’s much easier to come to a conclusion on something like Coca-Cola or Procter &Gamble than it is for a person who is spending only a limited amount of time on investing to make a decision on whether to own bank A, or bank B, or bank C.

Charlie?

CHARLIE MUNGER: Yeah, there’s another problem. Generally accepted accounting principles allow a conservative, sensible bank to show vastly increased earnings if it changes its practices to make a lot of extremely dumb loans in large volumes.

Generally accepted accounting principles should not be constructed to allow this result. It’s — that what seduces so many of these bankers into this ghastly decision-making.

WARREN BUFFETT: Yeah, when we bought Gen Re, they had a financial products division. It was named similarly to the AIG one. It was called Gen Re Financial Products — AIG Financial Products.

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And it produced numbers regularly that were always satisfactory numbers. But, you know, when we looked at that, you know, it looked like all kinds of trouble to us.

It cost us over 400 million to get out of. And a black box like that can produce — that’s why managements love them to some degree, they can produce numbers.

They don’t necessarily produce cash. And they sure as hell can produce all kinds of problems if you have to start posting collateral and doing things of that sort.

And I would say it is tough for, you might say, the passive investor, the one who’s not spending very much time on it. I would say it’s difficult for them to discern when that’s going on.

So I — it’s not a bad area to just say, “This one’s too tough,” and go onto something else that’s a lot easier.

I think you can analyze a utility operation easier or, you know, some premier consumer company or something of the sort.

I don’t think I would look for tough situations to differentiate tough industries in which to differentiate things.

But there are huge differentiations. And again, I urge to read the JP Morgan Chase — Jamie Dimon’s letter. Because you’ll learn a lot by reading that.

CHARLIE MUNGER: But a lot of the new regulation that is coming wouldn’t have even been needed if the accounting had done a better job, particularly in banking.

And yet, I have yet to meet an accountant from any of the big firms who have said, “I’m ashamed of my own profession.”

That’s a mistake in accounting. If they don’t have shame, they’re not thinking right.

 

 

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Dhruva Pandey
Dhruva looks for companies with a durable competitive advantage that are run by honest people, and available at a price that makes sense to him. His interests include technology, investing, markets, psychology, and chess.
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