2011: Have we done anything to prevent another bank bailout?

AUDIENCE MEMBER: Good afternoon, Warren and Charlie. My name is Phil Drew (PH), and I’m here with my wife Tina and our good friends the Grummys (PH) and the Henriksens (PH).

We’re all from Indianapolis, and we’re all small businesspeople. So we are not too big to fail.

And our question, basically, is simply this: do either of you gentlemen think that we might be headed down the same type of path years from now when we get into a situation as taxpayers, that we might have to bail out a company on Wall Street that is too big to fail? And if so, have we done anything to avert that?

WARREN BUFFETT: There are institutions around the world that I think governments should properly — although people won’t like it — but I think that there are institutions around the world that governments would properly — I think bailout has got a little bit of a pejorative term on it, in the sense that stockholders should not be saved, managers should not be saved — but certainly the institutions, in some cases, should not be allowed to collapse immediately.

I mean, right now, we’re continuing to follow that policy, for example, with Freddie Mac and Fannie Mae. I mean, they have not reconstituted themselves, as many of the banks and the auto companies.

I mean, Chrysler is even paying back, which, you know, surprises me, but my hat is off to them, and I mean that sincerely. I was really on the fence on saving the auto companies, but I think the administration did the right thing.

I mean, there were — they weren’t saving the auto companies, per se, they were still working at saving a very fragile economy.

And, like I say, particularly in retrospect, they certainly, in my view, made the right decision.

There are — right now, you know, in Europe they’re deciding whether countries are too big to fail.

And so I think that problem will always be with us.

I think for that reason that you have to do things to reduce the propensity to fail, and among those things, I think you have to make it so that the CEO, and to some extent the board — but not to the draconian degree that I’ll suggest for the CEO — I think that any institution that requires society to come and bail it out for society’s sake should have a system in place that leaves their CEO, basically, and his spouse, dead broke, because I think that the upside and downside incentives are vastly different. (Applause)

And I think the board of directors of those institutions should suffer severe penalties. Nothing like that, but they certainly, you know, should give back, say, the last five years of directors’ fees or whatever it may be that they received.

Because they — if you run an institution that actually needs — society can suffer such a blow if you fail — that society needs to come in and save you, you ought to have somebody running that institution, and you ought to have incentive practices in place that make it very, very, very painful to the people involved for the failure if it indeed happens.

And you also ought to reduce leverage in the system, and I think we’ve gone, to some degree, in that direction.

But there will be too big to fail institutions 10 years from now or 20 years from now. Right now Freddie Mac and Fanny Mae are sort of too big to figure out.

We just sit there — and incidentally, here’s nothing wrong with that. It’s more important to come up with the right solution than it is to come up with an immediate solution on those.

But particularly, I would say, in Europe there are banking institutions in countries that people are facing the question of whether they are too big to fail.

Charlie?

CHARLIE MUNGER: Well, my answer is that the past panics and depressions, by and large, started on Wall Street or in stock brokerages.

They tended to involve great waves of excessive speculation and bad behavior in the people who were profiting from those waves as salesman, or market makers, or promoters or what have you.

And I think that this last mess, which created so much danger, should have caused something like happened in the aftermath of the ’30s, where we prevented a new mess for a long, long time, but, of course, it hasn’t done that.

And so I think you can confidently expect a new mess or two before you career is over, and I think it is really stupid for our country to have allowed this.

Partly the failure is not one of evil, it’s one of stupidity. And part of the stupidity is in our great academic institutions who believe a whole lot of things that aren’t true. And that is a really hard problem to solve.

WARREN BUFFETT: You’re talking about particularly in finance?

CHARLIE MUNGER: Yes, of course, and economics, too.

WARREN BUFFETT: Yeah.

CHARLIE MUNGER: Those are not hard sciences, finance and economics. And finance really attracts people who should have gone into snake charming or — (Laughter)

WARREN BUFFETT: If there’s anybody we’ve forgotten to insult, just pass a note up, and we’ll get to you. (Laughter)

CHARLIE MUNGER: Yeah.