2016: How does Buffett feel about investing in investment banks?

AUDIENCE MEMBER: Hi, my name is Michael Mozia. I’m from Brooklyn, New York and I’ll be starting at Wharton Business School in the fall.

In an interview with Bloomberg Markets recently, Jamie Dimon defended the role banks play in financial markets, saying, “Banks aren’t markets. The market is amoral… You’re a trade to the market… A bank is a relationship.”

But banks, namely investment banks, have struggled as regulators have favored market-based solutions, and many of those relationships investment banks have worked so hard for have proven to be less lucrative, especially compared to the growing fixed costs of supporting them.

As it relates to our marketable securities portfolio, how do you feel about the investment banking component, particularly as Wells moves into that space? Would you feel differently if the cost basis was higher?

And Warren, Charlie, thank you so much for doing this every year.

WARREN BUFFETT: Thank you. Charlie, I didn’t totally get that, but does he feel the investment banking firms are being disadvantaged?

CHARLIE MUNGER: Well, he’s basically, how do we feel about — Jamie says —

AUDIENCE MEMBER: How do you feel about —?

CHARLIE MUNGER: You can’t make as much money as you used to out of relationships, and it’s getting tougher and so forth?

WARREN BUFFETT: Yeah. Well, the public policy since 2008-9 has been to, very much, toughen up capital requirements in a variety of ways for banks, but it is specifically been designed to make large banks- very large banks — less profitable relative to smaller banks.

And you do that by increasing capital requirements. You can change the math of banking, and the attractiveness of banking, totally, by capital requirements. Obviously, if you said every bank had to be 100 percent equity, it would be a terrible business. You couldn’t possibly earn any money that was significant on capital.

And if you let people operate with 1 percent capital ratios, they can make a lot of money and they will cause the system all kinds of trouble.

So, since 2009, the rules have been tilted against the larger banks by — primarily — through capital requirements. And that just means returns on equity go down, but returns on equity were awfully high prior to that. So it doesn’t — it hasn’t turned it into a bad business, it’s turned it into a less attractive business than earlier.

And that — some of the investment banks operate as bank holdings companies, still, and they’ve been affected by those capital requirements, too.

I’m not sure I’m getting 100 percent to your question, so I invite you to give me a follow-up, if you like, on that.

AUDIENCE MEMBER: In the marketable securities portfolio, do you feel good about the going-forward prospects of the investment — of the investment banking companies — especially as Wells Fargo moves into that business?

WARREN BUFFETT: Well, Wells Fargo has an investment banking aspect to it that primarily came in through Wachovia. And it’s not insignificant.

But our ownership of Wells Fargo, which is very large — it’s our largest single marketable security — I’m not counting Kraft Heinz, which is about the same size, because in that situation we’re in a control position — it’s the largest non-control situation that we have, at Wells Fargo.

And that’s by intent. I like it extremely well compared to other securities. Not because it has the most upside, but I feel that, weighted for upside and downside, that it’s —

CHARLIE MUNGER: It’s not the investment banking that charms you in Wells Fargo. It’s the general banking that —

WARREN BUFFETT: Yeah. No. We’re not — it isn’t that big a deal, and that’s not what attracts us.

We think Wells Fargo is a very well run bank. But, we didn’t make any decision to buy a single share based on the fact they were going to be more in the investment banking business because of the Wachovia acquisition.

They’ve got a lot of sources of income. They’ve got a huge base of very cheap money, but unfortunately, they’ve got it out at very cheap rates on the other side now. But, spreads will probably work in their advantage eventually. And we think it’s a very well run bank.

Investment banking business — Charlie and I are probably a little affected by the experience we had in running one for a short period of time — it’s not been something that we invested in significantly.

We, obviously, made a major investment in Goldman Sachs, and we continue to hold shares that came out of the warrants that we received when we made the investment in 2008.

But I think I can’t recall us making an investment banking purchase — a marketable security involving an investment bank — for a long time. Can you, Charlie?

CHARLIE MUNGER: No, I think, generally, we fear the genre more than we love it.