Freddie Mac (Federal Home Loan Mortgage Corp)

In 1988 we made major purchases of Federal Home Loan Mortgage Pfd. (“Freddie Mac”) and Coca Cola. We expect to hold these securities for a long time. In fact, when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds. Our holdings of Freddie Mac are the maximum allowed by law, and are extensively described by Charlie in his letter. In our consolidated balance sheet these shares are carried at cost rather than market, since they are owned by Mutual Savings and Loan, a non-insurance subsidiary.

Given the risks we accept, Ajit and I constantly focus on our “worst case,” knowing, of course, that it is difficult to judge what this is, since you could conceivably have a Long Island hurricane, a California earthquake, and Super Cat X all in the same year. Additionally, insurance losses could be accompanied by non-insurance troubles. For example, were we to have super-cat losses from a large Southern California earthquake, they might well be accompanied by a major drop in the value of our holdings in See’s, Wells Fargo and Freddie Mac. | Shares | Company | Cost | Market | | :--- | :--- | :---: | :---: | | 27,759,941 | American Express Company | $ 723,919 | $ 818,918 | | 20,000,000 | Capital Cities/ABC, Inc. | 345,000 | 1,705,000 | | 100,000,000 | The Coca-Cola Company | 1,298,888 | 5,150,000 | | 12,761,200 | Federal Home Loan Mortgage Corp. (“Freddie Mac”) | 270,468 | 644,441 | | 6,854,500 | Gannett Co., Inc. | 335,216 | 365,002 | | 34,250,000 | GEICO Corp. | 45,713 | 1,678,250 | | 24,000,000 | The Gillette Company | 600,000 | 1,797,000 | | 19,453,300 | PNC Bank Corporation | 503,046 | 410,951 | | 1,727,765 | The Washington Post Company | 9,731 | 418,983 | | 6,791,218 | Wells Fargo & Company | 423,680 | 984,727 |

Because there’s no one else in the world that will act as big or as promptly as we will. But we don’t write things that are unlimited. Now, the interesting thing is that the biggest exposures, in our view, are the people that write a lot of primary business and don’t have the catastrophe cover they need. I mean, if you write 10 percent of all the business in homeowners on — or 15 percent — on Long Island or in Florida, I mean, you are writing a catastrophe cover that would blow your mind. If you’re Freddie Mac or Fannie Mae and you’re guaranteeing mortgages, you know, for millions of people in areas like that, and they don’t have insurance — earthquake in California or property insurance in Florida — they’d be less likely to have earthquakes someplace — you are taking on enormous risks. I mean, huge risks, far beyond what we would ever take on. They just — but you don’t get paid for them, unfortunately. I mean, just take the New Madrid section of Missouri, down in the corner. That was the area of three of the greatest quakes, that are sort of related in time, in the — certainly in the recorded history, they were the three greatest quakes in the United States. You know, how much homeowners’ business, how much commercial property business, does somebody have in that huge territory, which you know, supposedly caused church bells to ring in Boston when it happened back in whenever it was — 1807, or ’9, or something like that? So, there are all kinds of risks that can aggregate in huge ways that companies are not thinking about at all. I mean, I don’t know whether Freddie Mac or Fannie Mae, for example, is demanding that all of the homes they insure in the, you know, 300-miles radius of New Madrid, have earthquake insurance. But, you know, it — that sort of thing never comes to mind until the unthinkable happens. But in insurance, the unthinkable always happens.

WARREN BUFFETT: Derivatives. Well, Charlie and I have expressed ourselves on derivatives. You know, we don’t think the probability, in any given year, is necessarily very high, that derivatives will either lead to or greatly accentuate some financial trauma. But we think it’s there. And I think it’s fascinating to look at something like Freddie Mac, where you had an institution that perhaps even hundreds of financial analysts were looking at — certainly many, many dozens of financial analysts were looking at. You had an oversight office. You had a creature that was created by Congress, presumably with committees that would be interested in their activities. You had on the board two of the smartest and highest-grade people that you could have, in terms of fixed income markets, in Marty Leibowitz and Henry Kaufman, and you had a bunch of other very good directors, too. And, with an auditor present, they managed to misstate earnings by some $6 billion in a fairly short period of time. Now, all of that wasn’t accounted for by derivatives, but a very large portion of it — 6 billion, that, you know, that is real money even — well, in any place. A large part of that was facilitated by activities and derivative instruments. Now you can look at the Freddie Mac annual report for 2000, whatever it is, ’2 or 2001. And you can read the footnotes and you can read the auditor’s certificate. And you can look at bunch of high-class, very smart directors. And you can be comforted by the fact that dozens of people in Wall Street, who are paid just to follow relatively few stocks, were studying this, and that they had conference calls all of the time. And in the end, what happened? It was 6 billion. It probably could have been 12 billion if they’d wanted. A lot of mischief can happen with derivatives. And as we’ve pointed out, Charlie and I have seen it happen.