Warren Buffett: Why Going To College Is A Waste Of Time

Key Concepts

• Endowment Growth vs. Tuition Costs: The disconnect between increasing university endowments and stagnant or rising tuition fees.
• Philanthropy & Higher Education: The allocation of charitable donations, particularly to universities, and the impact of bureaucracy and monopolies.
• Public Education Funding: The significant financial investment in K-12 education in the US, framed as an “entitlement.”
• Commodity Price Prediction: The acknowledged inability to accurately predict commodity prices (oil, soybeans, corn).
• Derivatives & Systemic Risk: The dangers posed by large derivative positions, particularly in the event of a major systemic disruption.
• Accounting & Derivative Valuation: Concerns about the accuracy and potential manipulation of derivative valuations, and the limitations of auditors.

University Endowments and the Cost of Education

The discussion began with a reflection on the experience of serving as a college trustee, witnessing an endowment increase from $8 million to over $1 billion without a corresponding decrease in tuition or increase in student enrollment. The primary focus of those managing endowments, it was stated, is simply to increase the endowment’s size. Warren Buffett noted, “That will be ever thus. That is the way humans operate.” Charlie Munger concurred, stating that expecting financial efficiency in American higher education is “howling at the wind.” While acknowledging the value of universities as “the glory of civilization,” Munger expressed disappointment with the effects of monopoly and bureaucracy within the system, even while supporting increased philanthropy towards them.

A key point raised was the substantial investment in public education. The US spends approximately $600 billion annually educating 50 million students (kindergarten through 12th grade), which Buffett framed as a significant “entitlement” often overlooked in discussions of social programs. He emphasized that the issue with the school system isn’t a lack of funding, but rather other contributing problems.

Commodity Price Prediction & Investment Strategy

The conversation shifted to the topic of commodity price prediction, specifically oil. Both Buffett and Munger explicitly stated their inability to accurately forecast commodity prices. Buffett recounted a past attempt to capitalize on future oil prices, admitting they “cashed it in too soon” and missed potential gains. He emphasized, “We don’t think we can predict commodity…We don’t know how to do it.” Investments are made based on factors other than commodity price predictions. Munger jokingly added, “I’m even more ignorant than you are. That’d be hard to be.”

Derivatives: A Systemic Risk

A significant portion of the discussion centered on the dangers of large derivative positions. Munger identified the primary risk as a “discontinuity” – a systemic shock that halts trading. He cited historical examples: the closure of the New York Stock Exchange after 9/11, during World War I, and the near-closure following the 1987 market crash. He warned that a major cyber, nuclear, chemical, or biological attack would likely cause such a disruption, revealing “enormous gaps” in collateralization and netting arrangements.

Buffett elaborated on a past experience at GenRe, where unwinding a “modest-sized” derivative position cost $400 million even in a benign market. He stated, “I do think it continues to be a danger to the system.”

Accounting Concerns & Derivative Valuation

The discussion then turned to the reliability of derivative valuations, highlighting potential issues with accounting practices. Munger recounted instances of significant mismarking of derivative positions, citing a $20 million discrepancy discovered during his time on the audit committee at Salomon Brothers. He described knowing of another position whose valuation was so inaccurate it was “staggering,” suggesting potential influence or incompetence in the marking process.

Buffett pointed out the inherent conflict of interest within the auditing industry, where the four major firms often audit both sides of a derivative transaction. He suggested that marks on these transactions are frequently “significantly different,” and that investigating these discrepancies would be a worthwhile endeavor. He expressed skepticism about the auditors’ ability to effectively prevent such issues, noting that the most profitable positions are often the hardest to accurately value.

Logical Connections & Synthesis

The conversation flowed logically from observations about university finances to broader discussions of economic systems and risk management. The initial point about endowment growth served as a springboard for examining the inefficiencies within higher education and the allocation of philanthropic resources. The inability to predict commodity prices highlighted the limitations of speculative investment strategies. Finally, the discussion of derivatives built upon these themes, emphasizing the potential for systemic risk and the challenges of accurate valuation.

The central takeaway is a cautious skepticism towards complex financial instruments and a recognition of the inherent limitations of human prediction. Buffett and Munger consistently emphasized the importance of understanding what you don’t know and avoiding situations where a single disruption could lead to catastrophic losses. They underscored the need for vigilance, particularly in areas where incentives are misaligned and transparency is limited.