This is the first of a multi-part series covering the Berkshire Hathaway 2008 Annual Report and Warren Buffett’s letter to shareholders. In this post, I will provide highlights of Buffett’s annual letter. In the following posts, I will attempt to determine the intrinsic value of Berkshire Hathaway based on the data available in the annual report and certain forward looking assumptions regarding the business.
The Annual Letter
Warren Buffett’s annual letter to shareholders is one of the most highly anticipated events of the year, and not just for Berkshire Hathaway shareholders. While Buffett provides a great deal of content regarding Berkshire’s financial performance, his views on the overall economy and political climate are even more widely followed. This year’s letter should be no exception. Since the following articles in this series will cover Berkshire’s operating results in depth, I will focus this post on a sample of Buffett’s comments regarding the economy.
“An Onslaught of Inflation”
Two comments in the letter clearly indicate that Buffett is not among those who believe that the economy is poised to enter a long term deflationary spiral. On page 3, Buffett refers to the Treasury and Fed as being “all in” when it comes to fiscal and monetary policy and he states that “one likely consequence is an onslaught of inflation”. Later in the letter (page 16), Buffett comments that the U.S. Treasury bond market of late 2008 may be regarded as bubble similar to the Internet and housing bubbles. I cannot imagine a stronger set of statements from Buffett or a better reason to stay as far away from treasuries as possible. While personally I will not short treasuries, I can bet that many others will make significant money if they have sufficient liquidity to sustain a short position in treasury bonds over a period of time.
Industries Dependent on the Feds
Buffett correctly notes that numerous industries are becoming more and more dependent on the Federal government and that “weaning these entities from the public teat will be a political challenge.” Buffett also observes that the costs of borrowing for highly rated companies like Berkshire is very high compared to Treasury rates, and that companies that find ways to obtain preferential treatment from the government will enjoy advantages. Such organizations have much lower borrowing costs even though Berkshire has pristine credit. “At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one.”
The Housing Market – A Need for Responsibility
Buffett writes at length about the housing market and the need for greater responsibility on the part of lenders and borrowers. Much of this discussion is in the context of the Clayton Homes business. Unlike most companies in the manufactured home business, Clayton did not engage in aggressive or deceptive sales practices and, as a result, default rates for borrowers is much lower than industry averages. No purchaser of mortgage backed securities backed by Clayton has ever lost a dime of principal or interest. Buffett notes that lenders made loans that they knew borrowers could not repay and borrowers counted on continued appreciation in home values as well as an assumption that refinancing would always be an option. Obviously, in hindsight, this proved to be a disaster for the housing industry and the broader economy. Most impressively, Clayton’s foreclosure rate of 3% of originated loans in 2008 was lower than the 3.8% rate of 2006 and the 5.3% rate in 2004.