Saturday, February 28, 2009

Berkshire Hathaway's Annual Shareholder Letter

Berkshire Hathaway's annual shareholder letter (PDF) was released today. Berkshire's decline in book value in 2008 was less than I would have expected, 9.6%. Below are a few brief excerpts.

Buffett On Some of his Mistakes in 2008:

I told you in an earlier part of this report that last year I made a major mistake of commission (and maybe more; this one sticks out). Without urging from Charlie or anyone else, I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.

I made some other already-recognizable errors as well. They were smaller, but unfortunately not that small. During 2008, I spent $244 million for shares of two Irish banks that appeared cheap to me. At yearend we wrote these holdings down to market: $27 million, for an 89% loss. Since then, the two stocks have declined even further. The tennis crowd would call my mistakes “unforced errors.”

On Why Berkshire Sold Some of its Stakes in JNJ, PG, and COP:

On the plus side last year, we made purchases totaling $14.5 billion in fixed-income securities issued by Wrigley, Goldman Sachs and General Electric. We very much like these commitments, which carry high current yields that, in themselves, make the investments more than satisfactory. But in each of these three
purchases, we also acquired a substantial equity participation as a bonus. To fund these large purchases, I had to sell portions of some holdings that I would have preferred to keep (primarily Johnson & Johnson, Procter & Gamble and ConocoPhillips). However, I have pledged – to you, the rating agencies and myself – to always run Berkshire with more than ample cash. We never want to count on the kindness of strangers in order to meet tomorrow’s obligations.

On Treasury Securities:

When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.

On the limits of Regulation:

For a case study on regulatory effectiveness, let’s look harder at the Freddie and Fannie example. These giant institutions were created by Congress, which retained control over them, dictating what they could and could not do. To aid its oversight, Congress created OFHEO in 1992, admonishing it to make sure the two behemoths were behaving themselves. With that move, Fannie and Freddie became the most intensely-regulated companies of which I am aware, as measured by manpower assigned to the task.

On June 15, 2003, OFHEO (whose annual reports are available on the Internet) sent its 2002 report to Congress – specifically to its four bosses in the Senate and House, among them none other than Messrs. Sarbanes and Oxley. The report’s 127 pages included a self-congratulatory cover-line: “Celebrating 10 Years of Excellence.” The transmittal letter and report were delivered nine days after the CEO and CFO of Freddie had resigned in disgrace and the COO had been fired. No mention of their departures was made in the letter, even while the report concluded, as it always did, that “Both Enterprises were financially sound and well managed.”

In truth, both enterprises had engaged in massive accounting shenanigans for some time. Finally, in 2006, OFHEO issued a 340-page scathing chronicle of the sins of Fannie that, more or less, blamed the fiasco on every party but – you guessed it – Congress and OFHEO.


JK said...

He didn't anticipate the fall in energy prices because he drank the kool-aid of the oil-pumpers that it was *only* supply and demand, not financial speculation in markets running prices up to a bubble. People who knew the oil market better, like Richard Rainwater, sold out on top or bet on a decline.

DaveinHackensack said...

He wasn't alone in thinking that. Matt Simmons was focused on supply & demand, and investors such as Heebner and Soros were buying PBR, for example, pretty high last year. I didn't think speculation played a significant role in the run up either. In hindsight, it does appear that it might have been responsible for the final leg up.

The more interesting mistake Buffett mentions, at least to me, is the Irish banks, because it implies a mistake of omission in not selling (or hedging) some of his domestic bank holdings. After all, Ireland had a real estate boom and bust too, so its banks had similar hurricane-force headwinds.