CNBC Buffett Transcript Part 7: What Should Happen to CEOs of Failed Companies

BECKY: Let me ask you a question that was sent in by a viewer. This is— control room, I'm jumping out of order— number six from Mark in Illinois. And this was written tongue in cheek, but he says, "You and Bill Gates have recently been trying to get extremely rich individuals to give half their wealth to charity. I was wondering about all the concern over our nation's serious debt issue. If the US citizens on the Forbes 400 list gave half their wealth to paying down the debt, how much of a dent would you put in it?"

BUFFETT: Well, the Forbes 400 had, I think, about 1.3 trillion last year, so that'd be about 650 billion. So in terms of the— in terms of the net debt, it would knock off about 7 or 8 percent.

BECKY: So you are talking about a serious dent with that. And I guess the question he maybe is asking in a more roundabout way is, why not give that money to the government instead of private charities?

BUFFETT: It would— it would— it would take about— it would wipe out about six months of the deficit, and then we'd back— we'd be back where we started. I do think that that group should be paying much higher taxes than they are, you know, and I think they— there should be higher estate taxes, too. But I don't think— I don't think you should have a tax system based on free will contributions. I'm not sure that would be the most successful tax system ever devised.

BECKY: OK. All right, well, we do have more to come. In fact, when we come back, we'll have a final go-round with Warren Buffett, a rapid-fire session to get through some of your last questions, and ours as well. Squawk Box will be right back.

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BECKY: Welcome back, everybody. It's time for a final round with Warren Buffett, so let's get right to some of the e-mails that you've been sending in. And, Warren, the questions that came in this year were extremely thoughtful. One that came in from Duane in Tribune, Kansas, writes in, "What do you think about the rapidly increasing prices paid for farmland across the country, and where do you see this trend going?"

BUFFETT: Well, my son is the farmer, and I'm not the big expert on it. But obviously, commodity prices have gone up significantly. And if they...

BECKY: Mm-hmm.

BUFFETT: If that represents a permanent factor, I mean, if you're really talking about $7 corn and $12 soybeans and so on, it makes the farmland worth more money. And of course, farmland does become more productive year after year. So, you know, a farm is a decent long-term investment. Generally they've sold on the fairly low yield basis, but good farmland is not a terrible investment.

BECKY: Yeah. You've seen prices crash, though, for some of these things very rapidly before.

BUFFETT: I don't know what will happen with commodities.

BECKY: Yeah.

BUFFETT: But what you're seeing with commodities to some extent is the— is the converse to the— to paper money. I mean, it...

BECKY: Mm-hmm.

BUFFETT: If money becomes worth less and less, copper and cotton and soybeans are going to be worth more and more, measured by dollars.

BECKY: Mm-hmm. Let's get to another question. Lindsay writes in from Cedar Rapids that, "Risk managers within many firms got it wrong, as evidenced by the financial failures and required government bailouts. Beyond the answer of maintaining a strong capital position like that of Berkshire Hathaway— obviously, not every company has the balance sheet of Berkshire— what's the most important advice you can provide with regard to risk management so that companies don't repeat the financial failures of the recent past?"

BUFFETT: Yeah, Well, financial companies always have— the CEO has to be the chief risk officer. And I think the boards of directors should have compensation policies that make sure that if the CEO fails in the risk job that that CEO goes away poor. I mean, I think that it's been disgusting, frankly, with huge financial institutions having— needing government assistance, all the disruption that's caused both in the institutions, the economy and everything else, and people walking away rich. So incentives matter enormously, and incentives have all been to the upside with managers. I mean, you have stock options, all of these things that if it works out they do great, and if it doesn't work out they still are very rich and they leave and, you know, it's goodbye, and then you need government money. So I think boards have been very derelict in the big financial institutions in the way they designed compensation packages. But they've been encouraged to do so by comp consultants and just by prevailing practice.

BECKY: Can we count on anything the government may do or has tried to do to this point with stopping that, or is this just always going to be a ticking time bomb?

BUFFETT: Well, the two big problems of the period were leverage and bad incentives.

BECKY: Mm-hmm.

BUFFETT: They've done some things about leverage, quite a bit. And the temptation is always just to leverage up more and more if you've got a financial institution. If you're— if you've got a government guarantee behind you, in effect, which the FDIC has been, or with Freddie and Fannie, you can print money. And when people get the ability to print money, they enjoy it. And then when you get the incentives wrong so that if things work they get paid off incredibly, and if things work they still get paid off incredibly, it— you're going to— you're going to have people do crazy things. So you got to have the incentives right, and you've got to have some limits on leverage.

BECKY: All right, we've only got...

BUFFETT: And we've made some progress on that.

BECKY: We have made some progress.

BUFFETT: Yeah.

BECKY: We've only got a few minutes left, but I'm hoping you can solve the problem with Fannie and Freddie and home mortgage issues while you're here. You did write about that in the shareholders letter this year.

BUFFETT: Hm.

BECKY: You wrote about your experiences through Clayton, and why Clayton has not had the types of bad loans that we've seen so prevalently through other areas in home mortgage.

BUFFETT: Yeah. Yeah. Well, we lent to people who put up reasonable down payments, and we verified their income. And these were people living on the edge, in many cases. I mean, these were not people with great FICO scores, everything, but they were buying homes not to flip them, they were not refinancing to try and take the money out to— they were— they were— they were keeping their monthly payments in line. And we were keeping the mortgages. We kept 11 billion or so of mortgages, three— 200,000 of them. So we cared whether the people were going to pay us in the future. If you have a government-guaranteed mortgage, you know, you don't care whether the person's any good or not. I mean, you know— well, you care whether the government's good or not, but you don't care. So when Freddie and Fannie guaranteed mortgages, the only person that could care was Freddie and Fannie. The people that bought them knew they were going to get paid because they knew, in effect, they were government guaranteed. Now, having government guarantees in there brings down the cost of financing to rock-bottom levels. I mean, it does reduce the cost of homeownership because you've got a government-guaranteed obligation.

I think going forth in the future, you may need some system where private guys— guys like me, guys like JPMorgan or whomever— have large mortgage guarantee operations backstopped by the federal government. So you get the benefit of the cost of that, but you have the discipline of the private market in terms of pricing these things and determining what you take and don't take. And you get it away from congressional pressure.

BECKY: So that nothing like a Fannie or a Freddie exists?

BUFFETT: You— I don't think you necessarily need Fannie or Freddie, but what you might— you might— let's just say you had a company capitalized at $10 billion and we own it. We couldn't take any money out of it for at least five years. And we guaranteed mortgages, and we took 80 percent of the guarantee, and the federal government took the 20 percent. But the government also said if for any reason this $10 billion company couldn't pay, they would pay. Now, we would have an interest in getting decent loans, we'd have an interest in getting paid reasonably. The government guarantee would probably never be called on, it would keep the price low. So you get the discipline of the private market, and you wouldn't have a whole bunch of lobbyists coming around to us and saying, `We want you to give money to anybody that shows up and, you know, can show a faint pulse.'

BECKY: Do you— do you think that that's actually a likely scenario, though? Do you think that there's the political will or desire to get the government entirely out of it?

BUFFETT: Well, I think— I think there's desire to get some answer to Freddie and Fannie. They all want to sweep it under the rug. It's the only thing, incidentally, that's cost the government a lot of money out of this whole panic.

BECKY: Right.

BUFFETT: The banks have pretty well paid things back, the FDIC didn't have to come up for any money, and the— even General Motors is doing reasonably well. So— AIG is going to get the money paid back. The big losers are Freddie and Fannie. And they were the ones run by government, and they were subject to government pressures. So I think that there's a desire for a solution that keeps the cost down— which government guarantees, too— but also imposes market discipline.

JOE: Hey...

BECKY: Joe:

JOE: Hey, Warren, is too big to fail— we keep hearing that it— that that wasn't fixed, that obviously the banks have gotten even bigger, the big ones. If you get their— the leverage better in order and make them, you know, keep more capital, and if you get the compensation or the incentives in order, is it OK to— in a capitalist system, to have things that're too big to fail, that would be bailed out? I— it seems like that's still a problem and we still have it.

BUFFETT: Yeah, you don't— but you don't want to bail out the managements. I mean, you know, in the case of— you know, Fannie and Freddie stockholders lost all their money. You know, the— AIG and Citi, you know, they're down— I don't know whether they're down 80 percent or what. The stockholders at WaMu lost all their money. The stockholders at Wachovia lost a very high percentage of their money.

JOE: Yeah.

BUFFETT: So they failed. Now, the— they didn't fail in the sense that you had a liquidation sale.

JOE: Right.

BUFFETT: And we tried that with Lehman and that didn't work out too well. There will always be, in my view, places that're too big to fail. But you could make it so that the incentives are that the people running them, if they...

JOE: Right.

BUFFETT: ...if the institution fails, they fail. That's enormously important, in my view.

CARL: Warren, I don't know if you saw...

BECKY: Carl:

CARL: I don't know if you saw the Oscars this past weekend, but the winner of Best Documentary was this film called "Inside Job," which paints a very dark picture of the crisis. And in his acceptance speech, the producer said that the— three years after a crisis that he says was caused by a massive fraud, in his words, not a single executive has gone to jail, and he says that's wrong. Is it?

BUFFETT: Well, I would say that what's really wrong is that the chief executives of most those companies walked away extraordinarily rich. Now, whether they should've gone to jail or not's a— you know, that's a question of statutes and whether you could prove it and so on. But I think the idea that they were allowed, by the terms of their contracts that they'd made and the boards of directors allowed to be put into place, that they could walk away with hundreds of millions of dollars while the country suffered the consequences of really some terrible actions. Like I said, I don't know whether it should put them in jail, but it should— it should not put them in Cadillacs.

BECKY: And, Warren, just wrapping things up again quickly, you are incredibly optimistic not only about America's futures, but about the stock market's future. Is that fair to say?

BUFFETT: I think— I think— I would— certainly fair to say that I would— if you asked me for owning equities vs. fixed dollars, either long-term or short-term...

BECKY: Mm-hmm.

BUFFETT: ...governments or anything, I know— I don't think there's a chance that governments will outperform equities over any, say, 10 or 20 or 30-year period. So I...

BECKY: Even with the big runs we've seen recent— oh, you're looking over the longer term. Yeah.

BUFFETT: Yeah, over the longer— I have no idea what'll happen in the next year.

BECKY: OK.

BUFFETT: But the— but I think it would be very, very foolish to have your money in long-term fixed-dollar investments or short-term fixed-dollar investments when you could— if you had the ability to own equities and own them for a— and hold them for a considerable period of time. You shouldn't own them with borrowed money.

BECKY: OK. Well, Warren, again, we want to thank you very much for your time here today, for being so generous with your time and taking so many of our questions and so many of our viewer questions as well.

BUFFETT: OK. I hope your viewers come out and look at the Durham Museum sometime, you know, enjoy it.

BECKY: That's right. Again, we're at the Durham Museum, for anybody who missed it. We're standing in front of the Ernest Buffett grocery store. Ernest Buffett, of course, was Warren Buffett's grandfather. And if you haven't read it already, check out the annual letter that he wrote. It tells you a little bit about a lesson that his grandfather taught him. But again, Warren, thank you.

BUFFETT: Thank you.

BECKY: Appreciate it. And, Carl, we'll send it back over to you.

CARL: OK. All right, thanks to Warren from both me and Joe.

JOE: Thank you, Warren. Yes.

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