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A Few Dark Clouds Over Omaha

Bearemy Glaser

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

There is almost always a strain of optimism running through the Berkshire Hathaway annual meetings, and this year was no exception.

But of course, there are also plenty of downsides that Warren and Charlie talk about, which investors should certainly consider.

The first one that they really talked about this year was the European banks. They are not very excited about the prospects of these banks being able to turn a true economic profit and to really be stable any time in the future. Unlike the U.S. banks that recapitalized, that took the time to get those bad mortgages off their books, the European banks really never went through that process, and instead of trying to get rid of sovereign debt, they think that [the European banks] could even be loading up on more sovereign debt right now. Charlie Munger talked about giving a guy on a margin account even more leverage to allow him to go out and buy more stocks. If it wasn't for the European central banks' flood of liquidity into that market, those European banks would be in a lot of trouble. It's something we have talked about a lot, but I think certainly Warren Buffett and Charlie Munger highlighted what a big problem this could potentially be for the global economy.

Energy policy was another big topic of discussion, and although Warren Buffett and Charlie Munger didn't exactly agree on exactly what's wrong with our energy policy, they both agreed that it's broken. I think that this might not necessarily be a short-term problem, but over the long term, investors really are going to have to be focused on energy policy, focused on how we're using our natural resources when they are thinking about what the future path of growth for the United States looks like. I think Warren and Charlie understand this. They really were talking about it more in this meeting than they have in the past, and I think it's certainly an interesting point to consider.

Another thing that they really were not very happy about--and pointed out as a potential problem--is the overuse of financial models to try to gauge risk. And to say, "Oh, look, we put it into this computer, we put it into this spreadsheet and therefore this is a risk-free transaction, and we don't need to worry about keeping this collateral, we don't need to worry about what's going to happen." They just see this as not really the way that you should manage risk in a corporation. They say that those kind of models just are never going to be able to give you the full amount of information. There is always going to be some tail events that you're never going to be able to consider, that you're never going to be able to fully account for, and therefore you should always be conservative. You should always be thinking about how you're going to get to play that next day, and how you shouldn’t be taking these unnecessary risks because some computer model told you to. I think that even though some companies have adjusted some of their models after the financial crisis, they are still relying on them very much, and I think that if those models turn out not to really be reflecting reality, we could find ourselves in another crisis ... a few years down the line if they are not really adequately capitalized, not really adequately insured for any kind of tail event.

Politics took up a surprisingly large amount of the meeting--discussion about the Buffett Rule and other political issues--and I think that the big takeaway from that, from Warren and Charlie in particular, was that our political system is broken--not that the United States is broken, not that capitalism is broken, or anything like that, but that the current political system just isn't capable of making the compromises and making the decisions that are needed to bring the United States back into fiscal balance and to put the policies in place that could really put the United States back on a track of sustainable growth. This is a point that a lot of investors and a lot of people at the meeting really took to heart. Some of the largest applause we saw throughout the entire meeting was when Warren talked about our broken political system, and again there weren't a lot of suggestions about how to fix it right now other than some of the specific policies that Buffett has been talking about previously. But I think it just highlights the political risk in the United States at the moment.

Now finally, Buffett's prediction for what growth is going to look like over the next 20 years is also certainly going to give some investors pause. Charlie Munger and Buffett think that about a 1% growth rate in real terms over the next 20 years would really be a very impressive feat and is something that they are expecting, but they think really would be almost as much as the United States could ask for.

Now, certainly when you add in inflation, in nominal terms that looks a little bit better [and] looks a little bit more like trend. But 1% real growth is certainly not gangbusters growth, and investors who were expecting a bounce out of this recession, a bounce that's really going to get us back to the kind of robust levels of growth that we maybe were seeing before the financial crisis, could be somewhat disappointed if these predictions come to pass.

So although there certainly were a lot of very optimistic comments from Charlie Munger and Warren Buffett over the course of the meeting--they are very bullish on the future of stocks and on the future of the United States' economy--they pointed out some potential downsides that could derail growth and really could keep things more muted in the future.

For Morningstar, I'm Jeremy Glaser.