2012: Will Berkshire's next CEO be able to negotiate deals like ones with Bank of America, GE, and Goldman?

CAROL LOOMIS: So for the first question, Warren, two shareholders wrote me about the heavy responsibilities that will fall on your successor and his or her ability to deal with them. So I’ll make this a two-part question.

From Chris Inge (PH), “Mr. Buffett, you have stated that you believe the CEO of any large financial organization must be the chief risk officer as well.

“So, at Berkshire, does the leading CEO candidate for successor, as well as the backup candidates, possess the necessary knowledge, experience, and temperament to be the Chief Risk Officer?”

The related question is about the Goldman Sachs, GE, and Bank of America deals, all giving Berkshire warrants, that you have negotiated.

Shareholder Jacques Cartier — Catere (PH), excuse me — asked whether these specific transactions could have been done with similar terms without your involvement.

If not, what implications would that have for Berkshire’s future returns?

WARREN BUFFETT: Yeah. The — I do believe that the CEO of any large, particularly financial-related, company should — it really should apply beyond that, but certainly with a financially-related company — should be the chief risk officer.

It’s not something to be delegated. In fact, Charlie and I have seen that function delegated at very major institutions, and the risk committee would come in and report every week, every month, and they’d report to the directors, and they’d have a lot of nice figures lined up, and be able to talk in terms of how many sigmas were involved and everything, and the place was just ripe for real trouble.

So I do — I am the chief risk officer at Berkshire. It’s up to me to understand anything that could really hit us in any catastrophic way.

My successor will have the same responsibility, and we would not select anybody for that job that we did not think had that ability.

It’s a very important ability. It ranks right up there with allocation of capital and selection of managers for the operating units.

It’s not an impossible job. I mean, it — the basic risks could involve excessive leverage and they — and then the — they could involve excessive insurance risk.

Now, we have people in charge of our insurance businesses that themselves worry very much about the risk of their own unit and, therefore, the person at the top really has to understand whether those three or four people running the big insurance units are correctly assessing their risks, and then also has to be able to aggregate and think how they accumulate over the units.

That’s where the real risk is, unless you’re engaging in a lot of leverage in your financial structure, which isn’t going to happen. Before I answer the second, Charlie, would you like to comment on that?

CHARLIE MUNGER: Well, not only was it — this risk decision frequently delegated in America, but it was delegated to people who were using a very silly way of judging risk that they’ve been taught in some our leading business schools. (Laughter)

So this is a very serious problem this man is raising. The so-called “Value at Risk” and the theories that outcomes in financial markets followed a Gaussian curve, invariably. It was one of the dumbest ideas ever put forward. (Laughter)

WARREN BUFFETT: He’s not kidding, either. We’ve seen it in action.

And the interesting thing is we’ve seen it in action with people that know better, that have very high IQs, that study lots of mathematics. But it’s so much easier to work with that curve, because everybody knows the properties of that curve, and can make calculations to eight decimal places using that curve.

But the only problem is that curve is not applicable to behavior in markets, and people find that out periodically.

The second question: we’re well equipped, Carol, to answer that question. We would not have anybody — we’re not going to have an arts major in charge of Berkshire. (Laughter)

The question about negotiated deal, there’s no question that partly through age, partly through the fact we’ve accumulated a lot of capital, partly the fact that I know a lot more people than I used to know, and partly because Berkshire can act with speed and finality that is really quite rare among large American corporations, we do get a chance, occasionally, to make large transactions.

But that takes a willing party on the other side. When we got in touch with Brian Moynihan at the Bank of America last year, I had dreamt up a deal which I thought made sense for us, and I thought it made sense for the Bank of America, under the circumstances that existed.

But I’d never talked to Brian Moynihan before in my life. I had no real connection with the Bank of America.

But when I talked to him, he knew that we meant what we said, so that if I said we would do 5 billion and — I laid out the terms of the warrants — and I said we’d do it.

And he knew that that was good and that we had the money.

And that ability to commit, and have the other person know your commitment is good for very large sums and, maybe, complicated instruments, is a big plus.

Berkshire will possess that subsequent to my departure. I don’t think that every deal that I made would necessarily be makeable by a successor, but they’ll bring other talents as well.

I mean, I can tell you the successor that the board has agreed on can do a lot of things much, much better that I can do.

So, if you give up a little on negotiated financial deals, you may gain a great deal, just in terms of somebody that’s more energetic about going out and making transactions.

And those deals have not been key to Berkshire. If you look at what we did with General Electric and Goldman Sachs, for example in those two deals in 2008, I mean, they were OK, but they are not remotely as important as, you know, maybe buying Coca-Cola stock, which was done in the market over a period of six or eight months.

We bought IBM over a period of six or eight months last year in the market. We bought all these businesses on a negotiated basis.

So the values in Berkshire that have been accumulated by some special security transaction are really just peanuts compared to the values that have been created by buying businesses like GEICO or ISCAR or BNSF, and the sort.

It’s not a key to Berkshire’s future, but the ingredients that allowed us to do that will still be available and, to some extent, peculiar to Berkshire, in terms of sizable deals.

If somebody gets a call from most people and they say, you know, we’ll give you $10 billion tomorrow morning, and we’ll have the lawyers work on it overnight, and here are the terms and there won’t be any surprises, they’re inclined to believe it’s a prank call or something of the sort. But with Berkshire, they believe it can get done.

Charlie?

CHARLIE MUNGER: Yeah, and in addition, a lot of the Berkshire directors are terrific at risk analysis.

Think of the Kiewit Company succeeding, as it has over decades, in bid construction work on oil well platforms and tunnels and remote places and so on.

That’s not easy to do. Most people fail at that eventually, and Walter Scott has presided over that bit of risk control all his life and very routinely.

And Sandy Gottesman created one of my favorite risk control examples. One day he fired an associate, and the man said, “How can you be firing me when I’m such an important producer?”

And Sandy said, “Yes,” he says. “But I’m a rich old man and you make me nervous.” (Laughter)

WARREN BUFFETT: Yeah. We do not have anybody around Berkshire that makes us nervous.