2005: How would a housing downturn affect carpet retailer and manufacturers?

AUDIENCE MEMBER: Hello. My name is Johann Freudenberg (PH) from Germany.

What do you think would be the consequences of a strong decline of the housing market for sales of carpet retailers and manufacturers? Thank you.

WARREN BUFFETT: Well, if there’s a strong decline in the housing market, my guess is that whatever we lose in carpet we’ll be making up for somewhere else, because it would — a lot of the psychological well-being, as well as the financial well-being, of the American people is tied up with the fact — or comes from the fact that they feel so good about what has happened with their home ownership over the years. And with many people it’s been, by far, the best-behaving asset that they’ve had.

So, if there is indeed some kind of a bubble and it’s pricked at some point, my guess is that we would feel that in various ways in our operating businesses, but that in terms of what we could do with our capital, the net effect to Berkshire might well be quite positive.

We’re not big on macro forecasts. I mean, this foreign exchange thing is quite different than what we’ve done over time and the way we’ve made money.

So, we are — it isn’t like we’ve got some great track record predicting macro factors and have made a lot of money doing that.

We’ve made money by looking at things like PetroChina, or whatever it may be, and just deciding that here is a very good business that’s selling at a very cheap price.

Certainly at the high end of the real estate market in some areas, I mean, you’ve seen some extraordinary movement.

And I’ve referred to this before, but 25 years ago or so we saw the same thing in farmland in Nebraska and Iowa and surrounding areas. We had people running from cash — “cash is trash” — and people wouldn’t, you know — they were worried about the fact that inflation was out of control in the late ’70s, and before [former Federal Reserve Chairman Paul] Volcker did his stuff, people were fleeing from cash.

And one of the ways they gave vent to that fear was to rush into farmland. There was a farm about 30 miles north of here that sold for about $2000 an acre in, roughly, 1980. And a few years later, I bought it from the FDIC for $600 an acre.

And you can say, how can you go crazy about farmland? It’s going to produce about 45 bushels an acre of soybeans, about 120 bushels an acre of corn. And there’s no way you could dream about a tripling, or the internet causing, you know, cornmeals to go up or something of the sort.

But people went crazy on it. And the consequences were huge, in terms of banks failing, lots of banks failing in this area, banks that had gone through the Great Depression. But the people went — they just want a little crazy.

People go crazy in economics, periodically, in all different kinds of ways.

And, you know, you had the Resolution Trust Corp. come out of the savings and loan nuttiness that took place in real estate, where they finance everything that was put before them.

And, you know, I will not — I don’t know where we stand in terms of the residential housing cycle in that it has different behavior characteristics, simply because people live in the houses in many, a great many cases. So it will not behave, necessarily, the same as other markets.

But when you get prices increasing at far, far greater rates than construction costs or inflationary factors, sometimes there can be some pretty serious consequences.

Charlie?

CHARLIE MUNGER: Yeah. It’s — in a place like Omaha, there’s not much of a housing price bubble, is there, Warren?

WARREN BUFFETT: No, there’s not been a bubble, but I would say that residential real estate, probably, has increased in price at a rate quite a bit faster than the general inflation rate.

CHARLIE MUNGER: Yeah, but if you get to Laguna, California or Montecito, California, or the better suburbs of Washington, D.C., you have a real asset price bubble.

I have a relative that, to move to a good school district in the suburbs of Virginia, she had to pay four times as much as she can get from selling her nice Omaha house.

WARREN BUFFETT: Yeah. Well, I sold —

CHARLIE MUNGER: So that’s a price bubble.

WARREN BUFFETT: I sold a house a few months ago in Laguna for $3 1/2 million. Now it sold the first day, so I probably listed it too cheap. So don’t count on me for residential real estate advice.

But that house, the physical house, would probably cost a half a million or thereabouts. So, in effect, the land went for $3 million, implicitly, and the land is probably on the area of 2000 square feet, which is a little less than one-twentieth of an acre. Now, you’ve got streets and all that sort of thing involved.

But basically, I think that land sold for about $60 million an acre, which that fellow that you saw in the farm outfit in the movie finds like — sounds like a pretty, pretty fancy price for almost any kind of land.

Charlie, you’ve witnessed it firsthand, though, out there.

CHARLIE MUNGER: Well, yeah. There’s — one of the Berkshire directors lives adjacent to what I regard as a pretty modest little house, which sold for $27 million recently.

Now these are houses that look right at the ocean, and there isn’t a great deal of available shoreline in California, and there are a lot of people.

But you have some very extreme housing-price bubbles going on. And you would think there might be a real possibility that it could go in the other direction someday.

WARREN BUFFETT: At $27 million, I’d rather stare at my bath tub. (Laughter)