Investment Wisdom

98. Wesco Annual Meeting 2008 – Part 2 – Tutelage 7-12

2008 Wesco Annual Meeting –  Notes courtesy of Peter Boodell
http://valueinvestingresource.blogspot.com/2008/05/2008-wesco-shareholder-meetingdetailed.html

Tutelage 7. Envy effects corporate compensation. People want to be paid like movie stars rather than archbishops.

Post Enron, accountants made mandatory that where the worse your credit gets the more profits you make. In the old system, the liabilities are always 100% good – it’s the assets you have to worry about. Accountants have thrown it out. They have made it standard. If you ask accountants about it, they say it is so complicated we won’t get to it in 3 yrs.

They want something simple to do. A silly procedure and silly result doesn’t bother them as long as it is in some book. That is not wisest way to run a profession.

Legal profession comes in for own opprobrium. Knavish people were deliberately blind. They didn’t want to wrestle punch bowl away from a couple burly drunks. I had a friend who once proposed a rule at the partnership that they would fire one client per year on moral grounds. They would get rid their most venal and dangerous client once a year. That proposal went down in flames. There is a certain amount of deliberate blindness. If you want to prevent, you must have whole lines of activity that people are not allowed to engage in. [more problems with sound system] We are in shadow of Caltech and we can’t get the sound system right. Envy effects corporate compensation. People want to be paid like movie stars rather than archbishops. I don’t think it is necessary. Most would occupy top position at lower compensation rate. It is terrible to civilization. It brings extreme envy into population at wide. In Britain, they took taxes so high that anyone with property was leveled down to growing their own tomatoes. It was not good, very counterproductive. It was matter of envy. The working population required it and it was reaction to envy effects. It is not good to have the results we have had.

Tutelage 8. There is a lot to be said that people in power make money with shareholders, not off them.

If we turn to Berkshire Hathaway, we have faults, but some of standard faults we deliberately avoid. Someone recorded what we would have had if Warren had paid himself 2 & 20. We would have had much lower taxes, so some other shareholders would have been better off, but Warren would have had 3x what he has now. Would world have been better if it had been run that way? I don’t think so. There is a lot to be said that people in power make money with shareholders, not off them. I’m not asking for an unreasonable ethos. It was compulsory in Athens. Liturgos, means required behavior. You had to give like hell if you were a leader. They had banishment. When language and traditions impose these… we might need it. We should restrict people in a more old fashioned way.

Tutelage 9. If you are an investment bank and had to be rescued, there should be limits on leverage and the complications of your business. There should be qualitative limits too. By and large banks behaved well when it worked this way.

Tutelage 10. Derivative trading, no good clearance, no rules, excess and craziness feeding on itself. The plain vanilla products got priced down to no profits. They wanted to do complicated stuff. Not sure if it cleared, or other side would be good for it.

I remember what I was going to say. Privileges. If you are an investment bank and had to be rescued, there should be limits on leverage and the complications of your business. There should be qualitative limits too. By and large banks behaved well when it worked this way. When I was young, Bank of America – would not have done things they do now. Derivative trading, no good clearance, no rules, excess and craziness feeding on itself. The plain vanilla products got priced down to no profits. They wanted to do complicated stuff. Not sure if it cleared, or other side would be good for it. It didn’t bother anyone since they wanted the profits. The hidden trouble in derivative books is awesomely large. Greenspan overdosed on Ayn Rand ethos. He never got it out of his system. As long as axe murders were a natural outcome, then they were okay. I don’t think it is necessary – and think you can regulate ax murders away. People talk about marvels of system and risk transfer – but some of our troubles COME from having so much risk transfer.

After South Sea Bubble, Britain outlawed public corporations – only private ones allowed. And they led the world for 100 yrs. A modest amount of liquidity will serve the situation. Too much liquidity will hurt human nature. I would never be tenured if I said that. But I’m right and they are wrong. We don’t need worst excesses. We do not need smartest people in science and math in computer driven strategies. This is not a plus for wider civilization. Derivative trading books – is one big clump of excess not having had its denouement.

Tutelage 11. By the nature of things, it will be difficult to make easy money.

I am now going to turn to a more interesting subject, the Berkshire Hathaway phenomenon. What are the lessons? On investment side, people are realizing that old fashioned idea of trying to get more value than you are paying for. I think that idea is gaining, and I think a plus for rationality. It doesn’t make it any easier. By the nature of things, it will be difficult to make easy money.

Tutelage 12. Bershire Way: Decentralize with Tiny Bureaucracy and Low Costs, Vast Autonomy at Subsidiaries, Not A Lot of Envy, No Big Overheads at Headquarters

How is it organized? I don’t think in history of world has anything Berkshire’s size organized in so decentralized a fashion. Net amount of bureaucracy is tiny, costs are low, autonomy in subsidiaries is vast, no common culture shuffling people around. How far can this go? This system has gone farther than any other system. Low cost, not a lot of envy effects – where everyone compares everything. People in subsidiaries have a feeling – whereby there is less fealty to headquarters. If you want an imperial headquarters which exacts a big overhead charge on the provinces – they will resent it. Net number of intrasubsidiary transfers is tiny. It has worked well. It can go a lot farther. No one else has been here before.

There are defects to the conglomerate system, where you have a separate quota system driven by headquarters driving provinces to meet central numbers. It causes a lot of expenses at headquarters. GE is good at running a conglomerate system. Berkshire has avoided the minuses. It can go farther. It has a system of running a financial system with low leverage and extreme willingness to let assets run out – that is quite rare. Most financial institutions talk our talk but don’t walk our walk. People can’t stand watching a place shrink. If you take General Re, they needed a derivative book like I needed a case of syphilis. It made headquarters more interesting. When we reached for money it wasn’t there. Out derivative book produced $400m of losses, and we were more conservative than most places.

We have moved to a hard mike, so please return to your seats. Microphone system has an educational value. What they should not be allowed to do – is anything that is too complicated. The hard mike system [vs the wired], lo and behold, is working as it always did. Systems need duplicative systems, back up system one, and back up system two.