2002: Are investment banks becoming more influential?

AUDIENCE MEMBER: I’m John Golob, from Kansas City. I’m mostly retired, but also teach a course on financial markets at the University of Missouri in Kansas City.

I always tell my students that I learned much more about investing at Berkshire Hathaway meetings than I ever did from my professors at the Wharton School. (Applause)

I have a general question about investment banks. Now, given your connection with Salomon, I’m always surprised at sort of the attitude you represent to this industry. Somehow I get the idea that you view them as just their main social value is charging very high fees for unnecessary churning.

I’m wondering if you have any perspective on the general influence of investment banks in U.S. finance that is — rising or falling.

I hate to be a Pollyanna, but I might hope that Enron-like debacles would reduce, maybe, the influence of investment banks, that people wouldn’t necessarily trust, you know, some of the advice they’re giving.

WARREN BUFFETT: I think Enron is bound to have some favorable fallout in various areas. I mean, it — to the extent that it causes people to look more carefully at how various entities behave and that sort of thing. No, I think Enron was a plus for the American economy.

And the truth is our capital system, you know, despite all kinds of excesses and errors and everything else, you know, one way or another, we’ve come up in this country with 50-odd-percent of the world’s market value for 4 1/2 percent of the world’s population.

So, you know, I’m not negative on how the American capital system has developed. I do get negative about how certain people behave within that system, but you know, they would behave badly in any system. So, you know, it’s the human condition.

But that is, you know, Charlie and I still think we should criticize things that we think are improper, but we don’t criticize the whole system in any way, shape, or form. It’s — you know, it’s been a tremendous economic machine in this country.

But I would say that a market system, and I don’t have anything better than — in fact, I think a market system is responsible in a material way for the prosperity of this country. So, I have no substitute in mind for the market system.

I do think it produces extraordinarily inequitable results, in terms of some overall view of humanity, and that that should be largely corrected by a tax system.

I don’t think it should be any comparable worth system or anything like that. I just — the idea of the government trying to — (laughs) — assign all that just strikes me as wild.

But the market system lets a fellow like me, you know, make so much money because I know how to allocate capital, you know, compared to a great teacher, or nurses, cancer — whatever. I mean, it just showers rewards on somebody that has this particular skill at this particular time.

And that’s great for me, but it should — there — in a really prosperous society, that should — there should be some corrective aspects to that.

Because it really strikes me as inappropriate that the spread of prosperity in a hugely prosperous economy should be decided totally by the quirks of skills that come into play and get rewarded so hugely from the market system.

So, I — but I, you know, I believe that — that’s why I believe in a progressive tax system, and so on.

I would say, in terms of investment banking particularly — I mean — (laughs) — I was standing one time with an investment banker, and he was looking out the window, and he said, “Just look.” He says, “As far as you can see, nobody’s producing anything.” And I said, “Yeah, that seems to be a mandate they take pretty seriously, too.” (Laughter)

But it — you know, there is a huge amount of money in a system, you know, with 14 trillion, or whatever it may be, of market values, and where people are spending other people’s money, and corporations, and where the more you spend for something, sometimes you get — gets equated with value as in fairness opinions, and all of that sort of thing.

It’s quite disproportionate to what I really think the ultimate contribution to the country is of various people, but I don’t have a better system — (laughter) — to substitute for it. I don’t want anybody to think — come away thinking that I think we ought to tinker with that very much.

I think that the — I think your tax system should be the way that you distribute the prosperity in a somewhat better way.

When we ask people to go to war, you know, or that sort of thing, we don’t take the person who’s made the most money and say, “Well, they benefited the most from society, so we’ll send them and put them in the front lines,” or anything like that.

I mean, we — there’s various aspects of being a citizen in this country that I think should make sure the people that don’t get the great tickets for — that make them prosper in a market setting, they still should do pretty darn well, as far as I’m concerned.

And really, people like me shouldn’t, you know —

It doesn’t make any sense to compensate me the way this world has. And it wouldn’t have happened if I’d been born in Bangladesh, or it wouldn’t have happened if I had been born 200 years ago.

You know, somebody — another one of those genie stories. Imagine, you know, when I was — 24 hours before I was born and there had been some guy with exactly my DNA right next to me, who was also going to be born in 24 hours. And the genie had come to the two of us and said, “We’re now going to have a bidding contest.

“And the one that bids the most of their future income gets to be born in the United States, and the one that loses in this is born in Bangladesh. And what percent of your future income will you give to be born in the United States?”

I’d have gone pretty high in the bidding. (Laughs)

You know, I mean, that would have been an interesting test of how important I thought my own abilities were compared to the soil in which I was going to be planted.

So, I, you know, I feel I’m lucky, and I am lucky, I mean, obviously. But I think we ought to figure out ways to take care of the people that are less lucky.

And I think that investment bankers should consider themselves in the lucky part of society.

And you know, there’s nothing wrong with what they do. Raising capital for American business is a fine thing and all that. I just think that they are paid, in relation to the talent and that sort of thing they bring to the game, I think they are paid obscenely high, but I think that’s true of me, too.

Charlie?

CHARLIE MUNGER: Yeah, the — but I would argue that the general culture of investment banking has deteriorated over the last 30 or 40 years. And it — remember, we issued a little bond issue, Warren, way back?

WARREN BUFFETT: Yeah, 6 million.

CHARLIE MUNGER: Diversified Retailing. And we had this very high-grade investment bankers from Omaha and Lincoln. And they cared terribly whether their customers, whom they knew, were going to get their money back.

WARREN BUFFETT: Yep.

CHARLIE MUNGER: And they fussed over every clause in the indenture, and they talked about whether we were really OK. And so, that was a very admirable process that we were put through.

WARREN BUFFETT: Yeah, we were screened in that.

CHARLIE MUNGER: We were screened, and intelligently screened. And it may not have been too intelligent to let us through, but it was an intelligent process.

And I’d say the culture on Wall Street lately has drifted more and more to anything that can be sold at a profit will be sold at a profit.

WARREN BUFFETT: Yeah. Can you sell it? That’s the question.

CHARLIE MUNGER: Can you sell it is the moral test. That is not an adequate test for investment banking. And —

WARREN BUFFETT: And there used to be two classes of investment bankers, too, really. I mean, there were the ones that did the screening and all of that.

And then there was a really low-class element that essentially merchandised securities no matter what they were. And there were clean lines, but the lines have disappeared.

CHARLIE MUNGER: Yeah, so it hasn’t been good to have this deterioration of standards in high finance.

And will it ever swing back? You would certainly hope so.

WARREN BUFFETT: You can see why were so popular at Salomon. (Laughter)

CHARLIE MUNGER: But in fairness, we had a very effective investment banking service from Salomon.

WARREN BUFFETT: That is true. That is true. And we — when we sold the B stock, for example, now we set the rules. And they wouldn’t have done it that way necessarily, but they did a very good job of doing it the way we asked them to do it.

And so, we said we don’t want people hyped into the stock. We want a very low commission and we’re going to issue as much as the market takes so that nobody gets excited about the after-market behavior and buys because they think it’s a hot issue.

I mean, we set a bunch of rules we thought were rational, and Salomon did a terrific job of following through on that and doing exactly what we asked them to. And it was successful by our standards.

So, no, I would say they did a terrific job in that case.

CHARLIE MUNGER: And they thoroughly enjoyed doing it, the people working on the job.

WARREN BUFFETT: That’s true.

CHARLIE MUNGER: They’d never done one like it before.

WARREN BUFFETT: That’s true. Yeah.

We’ve changed our whole opinion here in a matter of seconds. (Laughter)

CHARLIE MUNGER: Well, but there’s a lesson in that.

Certain kinds of clients get higher quality service than other kinds of clients. In fact, there are many clients who should never be accepted at all at investment banking houses, yet they are.

WARREN BUFFETT: Are you thinking of the fellow at Normandy? (Laughter)

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: I mean, can I you imagine that guy even getting in the door? I mean, it just — it blows your mind. I mean, he went to jail subsequently. He should have.

CHARLIE MUNGER: He was married to his high school teacher, who was at least two decades older than he was.

WARREN BUFFETT: Charlie has more opinions on this kind of thing than I do, but go ahead. (Laughter)

CHARLIE MUNGER: There were enough peculiarities in the situation. (Laughter)

I wouldn’t have thought it so peculiar, except that he was a man and she was a woman.