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The issue I want to address today, with the help of Buffett and Munger is: What to do with an investment when management have erred? At the Berkshire Meeting the two sages were reminded by a shareholder of one of their time-honoured principles: ‘Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.’
In that context, they were asked about Wells Fargo (which is in deep trouble with bank regulators ($1bn penalty so far) for ripping off customers in various way, including charging customers for duplicate insurance, wrongly fining mortgage holders when payment delays were the bank’s own fault, charging customers improper fees to lock in mortgage interest rates). Berkshire owns 9.9% of Wells Fargo’s shares with a market value of $26bn.
The questioner pointedly asked: “if Wells Fargo company is a chronically leaking boat, at what magnitude of leakage would Berkshire consider changing vessels?”
Buffett admitted that Wells Fargo had the wrong incentives for its staff, and that led to some crazy behaviour like opening non-existent accounts, “that is a cardinal sin at Berkshire.”
He pointed out that there are 377,000 employees and we can’t expect everyone to behave like Ben Franklin. So the company has to incent properly, and find out where things are going wrong and do something about it.
But Warren rejects the idea of always selling out when there are managerial problems:
“the truth is, we’ve made a couple of our greatest investments where people have made similar errors. We bought our American Express stock – that was the best investment I ever made in my partnership years – we bought our American Express stock in 1964 because somebody was incented to do the wrong thing in something called the American Express Field Warehousing Company.
We bought a very substantial amount of GEICO [in 1976] because somebody was incented to meet Wall Street estimates of earnings and growth. And they didn’t focus on having the proper reserves.
And that caused a lot of pain at American Express in 1964. It caused a lot of pain at GEICO in 1976. It caused a layoff of a significant portion of the workforce, all kinds of things. But they cleaned it up.… and look where American Express has moved since that time.
Look at where GEICO has moved since that time. GEICO…in the early 1970s….. charged the wrong price to new customers because they thought their losses were less than they were. And I’m sure some of that may have been a desire to please Wall Street or just because they didn’t want to face how things were going. But it came out incredibly stronger. You know, and now it’s got 13……
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