2011: What are the prospects for Berkshire's bank stocks?

AUDIENCE MEMBER: Jeremy Pozen (PH), Newton, Massachusetts.

Mr. Buffett and Mr. Munger, Berkshire Hathaway has had large investments in Wells Fargo and U.S. Bank.

What are the revenue outlooks and business prospects for these two banks, given the backdrop of slow U.S. growth, an extended U.S. consumer, a tepid rebound in the U.S. housing market with foreclosures and write-downs lessening but still at historically high levels, and the potential for greater-than-expected inflation, or worse, possibly, deflation similar to Japan?

Thank you for your time and consideration.

WARREN BUFFETT: Yeah, Wells Fargo and U.S. Bancorp are both among the best large banks, if not the best, in the country and they’re different than what you think of in terms of some money center banks, but they’re very large. Wells is four times as large as USB.

Banking as a whole — U.S. banking — profitability will be considerably less, in my view, in the period ahead than it was, say, in the early part of this century.

And a very important reason is that the leverage will be reduced. And that’s probably a good thing for society.

It’s — it may be a bad thing for individual banks that could use leverage intelligently, but the trouble was that they all thought they could use leverage intelligently, and the actions of one, or more, that were unintelligent about it, you know, had consequences for everybody, which you can see if you view HBO on whatever it is — is it May 26?

The — so I would say that return on assets — even if return on assets were as good as it was some years ago, there will be less assets per dollar of common equity than before which means returns on common equity will be less.

We still think that Wells Fargo and U.S. Bank are very good operations. We think they’re very decent businesses. They’re not as attractive as when leverage ratios could be higher.

In terms of the troubles in banking, I think you’ve seen, by far, the worst in the past. And loan losses have been trending downward now for several quarters, and I think the expectation is that will continue, and I think banking is a very fundamental business.

But as John Stumpf said a few years ago at Wells Fargo, he said, “I don’t know why we keep thinking of new ways to lose money when the old ones were working so well.” (Laughter)

And banks periodically go crazy. It’s always on the asset side.

I mean, here you’ve got cheap money. You’ve got the federal government behind, although the federal government has never had to pay out anything on — in terms of the FDIC.

The FDIC has handled 3800 since it was established on January 1, 1934. The FDIC has paid out probably 3800, 3900 by now, institutions, 250 of them or so in the last couple years. And that has not cost the U.S. taxpayer a penny. I mean, that has all come from FDIC assessments on other banks. It’s been a mutual insurance company.

Banking, if you just keep out of trouble on the asset side, is a very good business because you get your money so cheap and, you know, because of the implicit federal guarantee, and you do get to leverage up to a fair extent, and America’s been a pretty good place to lend money.

So I like our positions in there. You will see that — if you looked at those totals — you’ll see we’ve added to Wells Fargo. And both those companies are very well run institutions, but they will not be able to earn — I don’t know what the figures were, but I think they were up 25 or — to 30 percent on tangible equity — and that’s not going to get repeated in the future, and it shouldn’t be.

Charlie?

CHARLIE MUNGER: Well, yeah, we might add that M&T Bank, which most people —

WARREN BUFFETT: Oh, yeah.

CHARLIE MUNGER: — never talk about, is headed by a really sensible fellow, and it’s been a wonderful investment for us.

WARREN BUFFETT: Yeah, as a matter of fact, if you get the M&T annual report, it’s written by Bob Wilmers, the letter, the first part of it is about M & T specifically, but the second part is about particularly the American financial economy, and I would really recommend you read that.

Bob is a very smart guy and he has a lot of good observations.

And, frankly, the other one I recommend you read is Jamie Dimon’s letter, at JPMorgan, is a tour de force, in terms of describing the banking scene, the economic scene. He has some real insights in there about some very important subjects.

We don’t own that stock, but it’s a letter that I think everybody could learn a lot from reading, as they could from reading Bob Wilmer’s letter at M&T.

CHARLIE MUNGER: And those people who like an element of morality in business, Wilmer sounds like an Old Testament prophet.

I mean, he really doesn’t like it that all the really big banks are making so much money out of trading, because he says you’re really trying to outsmart your own customers, and he’d rather serve them in a culture of deserved trust in both directions. It’s hard to think he’s totally wrong.

WARREN BUFFETT: He also expresses quite a dislike for the fact that a market system creates a reward system where money sort of disproportionally flows to people who work with money, and that that tends to attract a disproportional number of people that — of lots of ability that he thinks might be — at least some of them — might be better deployed elsewhere. It’s an interesting read.

CHARLIE MUNGER: It’s one of the best annual reports that’s ever came out of banking. Right out of Buffalo.