2003: Why did Berkshire invest in a hedge fund that is levered more than 30 to 1?

AUDIENCE MEMBER: Hi, this is Steve Rosenberg (PH) from West Bloomfield, Michigan, now living in New York.

Mr. Buffett, the values that you and Charlie stand for and your supreme integrity are an inspiration. Thank you both for serving as such exceptional role models.

I have three quick questions for you. The first involves Value Capital — (applause) — L.P. Your preliminary FIN 46 disclosure appears to indicate leverage employed of roughly 20 billion in assets, 60 million in equity, or 30 to 35 times.

Without revealing any proprietary strategies, how do you derive comfort from this investment given your aversion to risk, other highly-levered partnership blowups, your enthusiasm in shutting down Gen Re Securities’ black box activities as soon as possible, and all of this, aside from the fact that it’s less than 1 percent of Berkshire’s equity, and that Mark Byrne is running it?

My second question involves manufactured housing. Can you comment some more on your enthusiasm for the underlying economics of the business, given what appears to be a commodity product with a high level of seller fragmentation, over-capacity, and large blowups on the financing side?

And what advantage — even if Berkshire’s advantage is in the financing, why not stick only to the financing and not the manufacturing?

And my final question involves the gains on securitization that you see in that segment.

Does the preponderance of gains reported indicate a mispricing of credit risk somewhere in the chain, perhaps analogous to the disconnect you were talking about between triple-B and triple-A spreads in the synthetic market and in the bond market? Thank you.

WARREN BUFFETT: Why don’t you elaborate on that third point on securitizations just a bit more? I’m not sure I totally have your point on that.

AUDIENCE MEMBER: Just the fact that usually you see gains rather than losses on securitization —

WARREN BUFFETT: Oh yeah.

AUDIENCE MEMBER: — all the time. Does that indicate that somewhere, when you’re slicing and dicing it, someone is paying too much, not taking the credit risk into — not valuing it properly.

WARREN BUFFETT: Yeah. OK. Three questions.

Value Capital is run by Mark Byrne, as you mentioned.

We’ve made a lot of money with the Byrne family. We made money with Jack, and we like Mark and Patrick, who we know — Charlie and I know very well.

And Mark is a very, very bright guy who runs what is, in effect, a hedge fund specializing in fixed income-type securities around the world.

And Mark and his family have significant money of their own in Value Capital, but we have 95, or so, percent of the capital in there. And we do not in any way guarantee their obligations.

Mark operates with a degree of leverage that is less than most people that operate in that field, but it’s a lot compared to the way we operate at Berkshire.

And that’s OK with us. We wouldn’t do it with a hundred percent of our money. We wouldn’t do it with 50 percent of our money. But we think it’s a reasonable business, as run by Mark, as long as he’s got a lot of money on the downside as well as the upside, which he does.

And he’s a very decent guy, in addition to being a very smart guy. So, we’re comfortable with that. It may have to get — the figures may have to get consolidated in our balance sheet.

We disclose them all now in our first quarter report. You will see them set out. And, in effect, we’ve got 600 and some million, a couple hundred million of retained earnings that Mark has earned for us, and we feel quite comfortable with that as an investment.

We do not regard it as a business part of Berkshire. The consolidated financial statements may make it look like we do, but it is not. We are a limited partner. We have a corporation in between. We have no guarantees of anything they do.

And we’re very happy with Mark running that piece of money, even though he does it, as you say, in fixed-income strategies that involve a lot of — they involve derivatives, they involve borrowed money. But I’ve looked at the positions and they all make sense to me.

And they would make sense, because Mark is a very smart guy, and the money means a lot more to him than it does to us. So, we feel OK with that.

We don’t like the idea of consolidating, in the sense that we don’t think it will make — we think it makes our figures less representative of what’s really going on than the way we handle it presently, but the rules are the rules and we’ll do what they say.

The second point. Charlie, do you want to comment on Value Capital at all?

CHARLIE MUNGER: No.