Warren Buffett's Berkshire Hathaway's 2008 Annual Letter

If you are interested in Warren Buffett's take on things, below is his always anticipated annual shareholder letter in its entirety. I am adding some snippets from a related AP story below for the Cliffs Notes version - one fun excerpt "the nation's economy will be in shambles throughout 2009."

Another excerpt is one we speak about often - unintended consequences and how are we ever going to get people weaned off government assistance after this episode.

In poker terms, the Treasury and the Fed have gone "all in." Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone's guess, though one likely consequence is an onslaught of inflation. Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won't leave willingly.

• Warren Buffett says the economic turmoil that contributed to a 62 percent profit drop last year at the holding company he controls is certain to continue in 2009, but the revered investor remains optimistic.
• Buffett released his annual letter to Berkshire Hathaway Inc. shareholders Saturday morning, and detailed the worst of his 44 years leading the Omaha-based company. But in between the news of Berkshire's sharply lower profit and its nearly $7.5 billion investment and derivative losses, Buffett offered a hopeful view of the nation's future. He said America has faced bigger economic challenges in the past, including two World Wars and the Great Depression.
• "Though the path has not been smooth, our economic system has worked extraordinarily well over time," Buffett wrote. "It has unleashed human potential as no other system has, and it will continue to do so. America's best days lie ahead."
• Within Berkshire, Buffett said the company's retail businesses, including furniture and jewelry stores, and those tied to residential construction, such as Shaw carpet and Acme Brick, were hit hard last year, and they will likely continue to perform below their potential in 2009.
• But he said Berkshire's utility and insurance businesses, which includes Geico, both delivered outstanding results in 2008 that helped balance out the other businesses.
• Buffett devoted nearly five pages of his letter to Berkshire Hathaway shareholders to explaining the role derivatives played in the company's investment losses last year. Buffett said he initiated all of Berkshire's 251 different derivative contracts because he believes they were mispriced in Berkshire's favor. "If we lose money on our derivatives, it will be my fault," Buffett said.
• Buffett said he did not anticipate last year's dramatic fall in energy prices, so his decision cost Berkshire shareholders several billion dollars.

www.berkshirehathaway.com

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[Feb 21, 2009: Bloomberg - Warren Buffet's Berkshire Drops to Lowest in 5 Years]
[Feb 3, 2009: Buffet Provides Financing to Harley Davidson]
[Nov 11, 2008: Goldman Sachs (GS) - Beaten, Bloody - Warren Buffet Down $2 Billion]
[Sep 23, 2008: Warren Buffet Finally Decides to Start Buying Distressed Assets]

Reuters has another summary here

ON THE 2008 FINANCIAL CRISIS "As the year progressed, a series of life-threatening problems within many of the world's great financial institutions was unveiled. This led to a dysfunctional credit market that in important respects soon turned nonfunctional. The watchword throughout the country became the creed I saw on restaurant walls when I was young: "In God we trust; all others pay cash." THE CREDIT MELTDOWN "By the fourth quarter, the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have never before witnessed. The U.S. -- and much of the world -- became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear." 2009 OUTLOOK "Most of the Berkshire businesses whose results are significantly affected by the economy earned below their potential last year, and that will be true in2009 as well. Our retailers were hit particularly hard, as were our operations tied to residential construction." MAKING MOVES IN THIS MARKET "During 2008 I did some dumb things in investments. I made at least one major mistake of commission and several lesser ones that also hurt. I will tell you more about these later. Furthermore, I made some errors of omission, sucking my thumb when new facts came in that should have caused me tore-examine my thinking and promptly take action. "Additionally, the market value of the bonds and stocks that we continue to hold suffered a significant decline along with the general market. This does not bother Charlie and me. Indeed, we enjoy such price declines if we have funds available to increase our positions. Long ago, Ben Graham taught me that 'Price is what you pay; value is what you get.' "Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down." IDENTIFYING ACQUISITIONS "Our long-avowed goal is to be the 'buyer of choice' for businesses --particularly those built and owned by families. The way to achieve this goal is to deserve it. That means we must keep our promises; avoid leveraging up acquired businesses; grant unusual autonomy to our managers; and hold the purchased companies through thick and thin (though we prefer thick and thicker). "Our record matches our rhetoric. Most buyers competing against us,however, follow a different path. "For them, acquisitions are 'merchandise.' Before the ink dries on their purchase contracts, these operators are contemplating 'exit strategies.' We have a decided advantage, therefore, when we encounter sellers who truly care about the future of their businesses." GEICO "As we view GEICO's current opportunities, Tony (Nicely) and I feel like two hungry mosquitoes in a nudist camp. Juicy targets are everywhere." REINSURANCE BUSINESS "From year to year, Ajit (Jain)'s business is never the same. It features very large transactions, incredible speed of execution and a willingness to quote on policies that leave others scratching their heads. When there is ahuge and unusual risk to be insured, Ajit is almost certain to be called. "Ajit came to Berkshire in 1986. Very quickly, I realized that we had acquired an extraordinary talent. "So I did the logical thing: I wrote his parents in New Delhi and asked if they had another one like him at home. Of course, I knew the answer before writing. There isn't anyone like Ajit." HOUSING MELTDOWN "At that time, much of the industry employed sales practices that were atrocious. Writing about the period somewhat later, I described it as involving 'borrowers who shouldn't have borrowed being financed by lenders who shouldn't have lent.' "To begin with, the need for meaningful down payments was frequently ignored. Sometimes fakery was involved. ('That certainly looks like a $2,000cat to me' says the salesman who will receive a $3,000 commission if the loan goes through.) Moreover, impossible-to-meet monthly payments were being agreed to by borrowers who signed up because they had nothing to lose. The resulting mortgages were usually packaged ('securitized') and sold by Wall Street firms to unsuspecting investors. This chain of folly had to end badly, and it did." OWNING A HOME "Home ownership is a wonderful thing. My family and I have enjoyed my present home for 50 years, with more to come. But enjoyment and utility should be the primary motives for purchase, not profit or refi possibilities. And the home purchased ought to fit the income of the purchaser. "The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability in the future. Home purchases should involve an honest-to-God down payment of at least 10 percent and monthly payments that can be comfortably handled by the borrower's income.That income should be carefully verified. "Putting people into homes, though a desirable goal, shouldn't be our country's primary objective. Keeping them in their homes should be the ambition." MUNICIPAL BOND INSURANCE "When faced with large revenue shortfalls, communities that have all of their bonds insured will be more prone to develop 'solutions' less favorable to bondholders than those communities that have uninsured bonds held by local banks and residents. Losses in the tax-exempt arena, when they come, are also likely to be highly correlated among issuers. If a few communities stiff their creditors and get away with it, the chance that others will follow in their footsteps will grow. What mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a far-away bond insurer? "Insuring tax-exempts, therefore, has the look today of a dangerous business -- one with similarities, in fact, to the insuring of natural catastrophes. In both cases, a string of loss-free years can be followed by a devastating experience that more than wipes out all earlier profits. We will try, therefore, to proceed carefully in this business, eschewing many classes of bonds that other monolines regularly embrace." MAKING MISTAKES "Without urging from Charlie or anyone else, I bought a large amount ofConocoPhillips (COP.N) 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 highe rin 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 year end 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.'" DERIVATIVES "Derivatives are dangerous. They have dramatically increased the leverage and risks in our financial system. They have made it almost impossible for investors to understand and analyze our largest commercial banks and investment banks. They allowed Fannie Mae and Freddie Mac to engage in massive misstatements of earnings for years. So indecipherable were Freddie and Fannie that their federal regulator, OFHEO, whose more than 100 employees had no job except the oversight of these two institutions, totally missed their cooking of the books."

Comments

[User 335273:]

Two comments. Scribd sucks. Paragraphs are your friend.

Mar 01 07:54 PM

[Jolly_Rancher:]

It is apparent that we can take Warren Buffett at his word that he does not know what direction the markets are going. Next we can take him at his word that he is human and therefore makes mistakes. One glaring example of this is his purchase of COP at the peak of oil prices. But what is odd about this purchase is COP at the prices he paid is not at all a purchase supported by the methods of Graham-Dodd. Further, the sale of the index puts at the peak of the equity markets again seems to be an error of the same ilk. Same for the Burlington Northern purchase. I can understand errors made where there is an apparent margin of safety when he buys a company whose stock has been cut by 80% but whose business prospects 10 years out are quite good. But I don't understand errors made due to a break with his basic investment philosophy. Does he simply have too much money that has to be put to work within a limited time span? Or is he just getting sloppy? I'm not trying to malign Buffett whom admire.

Mar 01 08:22 PM

[{5U}:]

Old guys are krazy. Remember Kapitan Kirk Keokrian with GM and Ford? There comes a time in Old Doods' lives when they care more about legacy and proving they can still get it up than rational investing decisions.

I think Buffet wants to be remembered as a patriot. He has more than enough money. At this point he wants his legacy as the man that helped save America and not as the hedge fund whipersnappers of Wall Street that destroyed it.

I gotta give The Buffet credit. He is a man willing to go down with the ship.

If he wasn't so old I'd like to get a serving of some BRK.B at The Old Country Buffet. But like every great company with a charismatic leader, it is buyer beware when The Bill Gates, Jack Welsches, and Steve Jobs of the world step down.

Mar 01 09:58 PM

[icandoitdon:]

yes, i think buffet (whom i also admire) might have stayed on a bit too long. assuming the risk of equity puts at the top of the market, investing in BNI and COP....these were, then and now, hard to understand.

as for jack welch, i can't think of a more overrated executive than him. he's the man who managed earnings for years through accounting trickery when it was given a wink and a nod by everyone, including the SEC. he's also the man who inflated GE earnings by turning that once proud industrial giant into a god damned bank...and a lousy one at that. he couldn't shine the shoes of gates, jobs or buffet.


On Mar 01 09:58 PM Equity Has No Clue wrote:

> Old guys are krazy. Remember Kapitan Kirk Keokrian with GM and Ford?
> There comes a time in Old Doods' lives when they care more about
> legacy and proving they can still get it up than rational investing
> decisions.
>
> I think Buffet wants to be remembered as a patriot. He has more than
> enough money. At this point he wants his legacy as the man that helped
> save America and not as the hedge fund whipersnappers of Wall Street
> that destroyed it.
>
> I gotta give The Buffet credit. He is a man willing to go down with
> the ship.
>
> If he wasn't so old I'd like to get a serving of some BRK.B at The
> Old Country Buffet. But like every great company with a charismatic
> leader, it is buyer beware when The Bill Gates, Jack Welsches, and
> Steve Jobs of the world step down.

Mar 01 10:21 PM

[HiSpeed:]

I'm surprise that Buffet is now shorting puts and getting in the CDS market since he always said derivations were financial weapons of destruction. If the market continues lower with no recovery by the time those derivatives are due, it'll be a mega-disaster for BRK.

Mar 01 11:46 PM

[Dave Shafer:]

If "the market continues lower with no recovery by the time those derivatives are due [2018-2020], then it will be a mega disaster for" the world economy.

Mar 02 08:34 AM

[long_on_oil:]

I bet 99% of us made the same mistake Buffet did with respect to COP; I know I did. During the decline in oil from 145 to 100 all you heard every night on the financial TV networks was what a buy the oil companies were. T Boone Pickens made a case for oil setteling in at around $100 and he is the smartest oil man in the U.S. Very few investors saw oil going to $35 so COP looked great at $50, hell, it still looks like a major bargain.
I know nothing about derivatives but I am sure Buffet does, so I trust him to do the right thing there. Bottom line Buffet is no different than the rest of us with the exception that he admits his mistakes in public.
I sure hope he keeps the COP because with the turmoil in Mexico plus the Iraq government begging for the major oil companies to come in and develop their fields; COP is going to prove to be an excellent investment at the price Buffet paid.

Mar 02 09:04 AM

[Mad Hedge F...:]

HH ds a “If you have been playing poker for a half an hour, and you don’t know who the patsy is, it’s you,” said Warren Buffet.

Mar 02 09:31 AM

[Michael Zhuang:]

It is too early to write Buffet's obituary. He was ridiculed for full three years during the internet bubbles, and guess who had the last laugh?

Besides, what's so unusual about making mistakes, what's unusual is openly admitting it.

In final analysis, his letter is still one of the best education material for investors. If you don't have time to read the full 23-pages, at least read the excerpts:

investmentscientist.co.../

Mar 02 11:17 AM

[secmaven:]

No tree grows to the sky an BH is not going to compound its wealth forever either. In two years BH will be a sub $10,000 stock.

Mar 02 12:17 PM