On a 3 hour interview with CNBC's Becky Quick, Warren Buffett made several interesting comments on the US economy and on Freddie and Fannie.
- QUICK: ... One of the things we'd like to get straight to, though, is what you see happening in the economy right now. We've been talking to you for some time about what you see as some significant problems in the economy. And, from your perspective, have things gotten any better? Have they gotten any worse?
BUFFETT: No, they've rippled out some, and that's what you'd expect. So the excesses in credit, the deleveraging that was required, the weak credits that are exposed, all that is--we're seeing manifestations out as the ripples go out, and I think I said one time that, you know, you only find out who's been swimming naked when the tide goes out. Well, we found out that Wall Street has been kind of a nudist beach. There's--it's just one discovery after another of firms that either didn't know what they were doing or that did things that they shouldn't have knowingly. And all of the troubles have not been revealed the first time around, usually, so there's considerable disillusionment that's set in in terms of are these guys telling us the truth now or maybe they just don't know what the truth is. So all of that's having an effect, and what we're seeing in business, in our retail businesses...
QUICK: Mm-hmm.
BUFFETT: ...certainly, anything to do with housing is even a further slowing down. I mean, June and July, both in terms of credit experience with people that first got into trouble of house payments and now on credit card payments and so on. And retail trade, it's not over by a long shot.
QUICK: Does that make you think that things are going to continue to decline over the next, let's say, six months?
BUFFETT: Oh, I think they could easily go beyond that, yeah.
QUICK: What's your prognosis, or what's your best guess or your best estimate of what...
BUFFETT: You never know. I've said in the past it ought to be longer and deeper, and I think it is going to be longer and deeper, but no one knows when--what you do know is that it will turn around. I mean, the country will be doing far better five years from now than it is now, but it won't be, in my judgment, it probably won't be doing better five months from now.
QUICK: You talk about how this has rippled out and it's affecting the consumer at this point. Have the credit markets themselves gotten any better?
BUFFETT: Well, the credit markets have had this situation where periodically it's seemed like they were getting better and then something else comes along. So the bankers feel a little bit better for a while and then something comes along and then they want to deleverage further. They find out they've got more trouble. Right now, for example, they're taking back all these auction rate securities. Well, they don't want to take things out of their balance sheet. So it's just one more problem for them, and you've seen these waves of problems and sometimes they create their own momentum. I mean, if the stock prices go down enough of the banks, then they feel like they can't sell securities. Of course, the extreme example was Freddie Mac was--has sort of been chasing a rabbit down the hill...
QUICK: Right.
BUFFETT: ...and promised they would raise additional money and of course the price of the stock got to the point where it became ridiculous. So troubles feed on themselves.
QUICK: Let's talk about Fannie Mae and Freddie Mac, specifically. These are two stocks that it seems like every time you turn around are touching new low levels. There's a lot of concern out there on the market about these two stocks right now. What's your general take on how they got here and what you think's going to happen next?
BUFFETT: Well, how they got here was they had two businesses, basically.
QUICK: Mm-hmm.
BUFFETT: They insured mortgages on a huge scale, trillions, and then they ran sort of a hedge fund, a carry trade where they bought mortgages and borrowed extensively against them. And because they had really the backing of the United States government--and everybody assumed they had the backing. I assumed it. And the truth is they do have the backing of the United States government in terms of their debt, not in terms of their equity--they were able to borrow without any normal restraints in terms of capital or margin requirements or anything of the sort. They had a by-check from the federal government.
QUICK: Mm-hmm.
BUFFETT: And they also had an added problem in that they had a dual mission. The government expected them to promote housing and the stockholders expected them to raise the earnings substantially every year. And as the years went by, they emphasized the latter more and more. They started talking about "steady Freddie," and Fannie Mae said, `We're going to increase the earnings at 15 percent a year.' Any large financial institution that tells you that sort of thing is giving you a line of baloney. I mean, they may do it for a while, but when they can't do it with operations, they do it with accounting and they cheat. And that's what happened at both those places on a huge, huge scale. And we have this--they're so wound up with national housing policy, that they're a national problem and, with this dual situation, you know, Lincoln said a house divided against itself, you know, must fall. And they existed half-slave, half-free for a long time, and then the motivations became in conflict, and when they got on the 15 percent a year merry-go-round and said, you know, `We're going to deliver earnings up every quarter, and we'll meet them to the penny,' when they can't do it operationally, they do it with accounting.
QUICK: So what happens now? You mentioned that this is all tied up with the national housing situation now. Are they two big to fail, and what does that mean?
BUFFETT: Yeah, they're too big to fail.
QUICK: Yeah.
BUFFETT: So that doesn't mean that the equity can't get wiped out, and it almost has in the stock market, and in practical sense as institutions, they don't have any net worth. I mean, if you look at their obligations and look at the fact they have big deferred tax assets as assets. They would've been gone in any market where the government wasn't behind them long, long ago. But the government is behind them, and they will stay behind them, and people that own insured mortgages or who own their debt, I think--nothing's going to happen to them. The equity and the preferred stock is another question and I think you'll see some action fairly soon. You've already seen it in the fact that the Treasury has made pretty much explicit what was formerly implicit.
On derivatives.
- QUICK: You've come out and said derivatives are the weapons of financial mass destruction before. But you use derivatives, too.
BUFFETT: That's right. I don't say they're evil, per se.
QUICK: Yeah.
BUFFETT: I just say that once the genie opened the bottle on those many years ago, that their proliferation, their variation, their inability to be valued and their ability to allow institutions to pile up leverage like the world has never seen can cause great systemic problems. And that doesn't mean, you know--it's like gun powder or water. You can do damage with a lot of things, but these have systemic--they pose systemic risks. And incidentally, the government recognizes this. I mean, you've had a task force working on, you know, what do we do to prevent these things from causing a real problems? But they have caused problems so far. I don't think they're going to cause problems at Berkshire Hathaway. I know every single derivative contract we have. Now, when we bought Gen Re, they had 23,000 plus contracts.
QUICK: Mm-hmm.
BUFFETT: There was no way in the world I can get my mind around that. I mean, if I--if I had spent full time and had all kinds of assistants and everything, I never would've known what was in those contracts. We had one contract that was due in 100 years, so that meant that for 100 years some guy at our place put a mark on it every day and some guy at another place put a mark and they got their bonuses based on it. I mean, that is a system that is guaranteed to cause trouble. And so I got out of the business. It took me four years under benign market conditions, and we lost $400 some million in the process. So they are dangerous things. The ones we put on may be dangerous things, too, but I do know every contract, and I know what my gain-loss arrangement is and nobody else marks them. I mean, I keep track of it.
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