"I.O.U.S.A.", Further Decline, Fannie Mae, Freddie Mac, OFHEO
QUICK: The film premiered on hundreds of movie screens across the country last night, including right here in Omaha. After the debut, I got the chance to moderate a town hall meeting with the men who were behind the movie, Blackstone's Pete Peterson and former US Comptroller General David Walker. Warren, this was a discussion with five of the brightest minds of people who are looking out there at the economy, and there is some debate as to how big of a problem this is.
BUFFETT: Yeah. There was a debate last night as a matter of fact.
QUICK: Right.
BUFFETT: And the film takes the position pretty universally throughout the film that it's an enormous problem, and I probably represented the group that thinks this is quite a bit less of a problem than the film portrayed. But I admire the people that did it in that there's so little thinking done beyond the next electoral event that there are important policy matters that do extend way out into the future and--whether it's energy, whether it's the question of weapons of mass destruction, certainly in terms of fiscal policies. So I admire the fact they tackled the subject. I don't--I don't agree with many of the conclusions in the movie. [Buffett is a long-term bull. Things get screwed up when people do foolish things no matter what the regulation is, and they always will. Buffett likes to buy when the markets are on sale. "I mean, you don't want a capital market that functions perfectly if you're in my business." [1] Buffett is the most celebrated investor of all time, and has personally been through a number of recessions and the Second World War.]
QUICK: But we did have a huge discussion on this last night. And, in fact, we'll be joined by both Pete Peterson and Dave Walker a little later this morning to talk more about what they see happening in the economy, and it's something we're going to be talking about throughout the morning. So again, Warren, we're thrilled to have you here this morning for three hours, and we do have a lot to talk about today. 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. [Yes, that's what you'd expect. But last year Bernanke was telling us that the subprime problem was nothing compared to the US economy and it will be contained; the Fed promised "no recession" and price stability [2]. Now the Fed has been proven wrong!] 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. [What we are witnessing now is the deleveraging of *both* the credit and US housing bubbles. The deleveraging process continues... and is not over by a long shot, as described by Buffett.]
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. [Yes, is going to be longer and deeper. This is consistent with what Buffett has said before [3], as well as Nouriel Roubini [4, 5], George Soros [6], David Tice [7, 14], and Michael Steinhardt [8]. We at bhc investment believe the US unemployment has yet to show its worst and commercial real estate is now also in a process of a major correction [14].] 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. [So they cheat!]
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. [There are winners and losers here. Clearly, losers are those who are still holding on to those heavy bags of the stocks. Winners are those who foresaw the crisis coming and shorted the stocks at the highs -- this includes John Paulson [9], James Chanos [10], Jim Rogers [11], and David Tice [14]. If we are not mistaken, Chanos has covered his shorts. Bill Gross [12], manager of the world's biggest bond fund at Pacific Investment Management Co., was also smart enough to have invested in the bonds, as he knew the Treasury will bail out Fannie Mae and Freddie Mac.]
QUICK: Do you say that knowing anything? Do you know there's a behind-the-scenes plan?
BUFFETT: No. I don't know. No. They--I'm not getting called on it.
QUICK: OK. You're not getting called on this, but you do...(unintelligible).
BUFFETT: I'm not getting called on that specific aspect of it.
QUICK: All right. Now you're telling me we're warm.
BUFFETT: They're looking--they're looking for help, obviously.
QUICK: Right.
BUFFETT: And the scale of help needed is such that I don't think it can come from the private sector.
QUICK: So there could have been a situation where you've been called in the past and you passed on any involvement?
BUFFETT: Yes. They were looking for--they, obviously, had been looking for money. They say that.
QUICK: Mm-hmm.
BUFFETT: And they were told to look for money and--but even the amount of money they were told to look for would be inadequate. I mean, 5 1/2 billion at Freddie would be, you know, that'd be like taking a spoonful out of the Atlantic to try and save the Titanic.
QUICK: How much to you think they need?
BUFFETT: They need a lot. But to get back to the confidence that they had and all of that, it takes far more now. I mean, an ounce of prevention really is worth a pound of cure.
QUICK: If you imagine where things will go with Fannie and Freddie, and you think about the regulators, where were the regulators for what was happening, and can something like this be prevented from happening again?
BUFFETT: Well, it's really an incredible case study in regulation because something called OFHEO was set up in 1992 by Congress, and the sole job of OFHEO was to watch over Fannie and Freddie, someone to watch over them. And they were there to evaluate the soundness and the accounting and all of that. Two companies were all they had to regulate. OFHEO has over 200 employees now. They have a budget now that's $65 million a year, and all they have to do is look at two companies. [A bunch of more than 200 employees sleeping at the switch!] I mean, you know, I look at more than two companies.
QUICK: Mm-hmm.
BUFFETT: And they sat there, made reports to the Congress, you can get them on the Internet, every year. And, in fact, they reported to Sarbanes and Oxley every year. And they went--wrote 100 page reports, and they said, `We've looked at these people and their standards are fine and their directors are fine and everything was fine.' And then all of a sudden you had two of the greatest accounting misstatements in history. You had all kinds of management malfeasance, and it all came out. And, of course, the classic thing was that after it all came out, OFHEO wrote a 350--340 page report examining what went wrong, and they blamed the management, they blamed the directors, they blamed the audit committee. They didn't have a word in there about themselves, and they're the ones that 200 people were going to work every day with just two companies to think about. [A bunch of more than 200 pathetic report writers!] It just shows the problems of regulation.
QUICK: That sounds like an argument against regulation, though. Is that what you're saying?
BUFFETT: It's an argument explaining--it's an argument that managing complex financial institutions where the management wants to deceive you can be very, very difficult. Or even when the management doesn't know what's going on, and--just take Bear Stearns. Bear Stearns had--I read it, anyway--750,000 derivative contracts. Now, you know, I could clone Albert Einstein, you know, and--many, many times and have him work 12-hour days for me and he would not be able to keep track of what's going on in an institution like that. It's--the ones that are too big to fail may be too big to manage, in some cases. And they're particularly difficult to manage if they're promising Wall Street and their investors that they're going to do things that can't be done.
QUICK: You've come out and said derivatives are the weapons of financial mass destruction before. [A video on CDO can be found in [13].] 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. [Buffett wisdom: Focus on what your can understand and stay within your circle of competence.]
QUICK: You do it yourself on every one. OK. Warren, we have a lot more to talk about with you this morning. We'd like to get to some of your holdings, more on the economy, but we also are going to take a very quick pause right now for a quick break. When we come back, Carl's going to be joining us again from China and Carl, what's on your mind?
QUINTANILLA: Becky, if that's the A-block, I cannot wait to see the rest of the show. Wow. What--that's great insight from Mr. Buffett from OFHEO to derivatives, you name it. We'll get more from the world's most successful investor and an Olympic update as we head into closing ceremony on Sunday night. Becky's in Omaha, I'm in Beijing. This very special edition of SQUAWK BOX continues in just a moment.
Coca-Cola, Olympic 2008, China
QUICK: All right, welcome back, everybody. You know, Warren, we know that you are a huge sports fan. You're somebody who watches all sorts of things, and, of course, one of your major holdings, Coca-Cola, so what better way to tie all this up than Coca-Cola, sports, you've got one of the major sponsors of the Olympics here. Let's bring Carl back into this conversation from Beijing. And appropriately, yeah, Warren is holding up his Coca-Cola just right now, Carl. So, as always, he's got a cherry Coke by his side.
QUINTANILLA: Cherry Coke, yes.
QUICK: Yeah, cherry Coke by his side. And, Warren, we've been talking all things Olympics the whole way through. What do you think about Coca-Cola and the major sponsorship that it has with the Olympics?
BUFFETT: Well, it has a long, long history with the Olympics, and it--it's very important. I mean, Coca-Cola wants to be associated with happiness around the world. Every major event they want to be here. And it's important--with a brand, there's something in the mind about a brand. I mean, you have something in your mind about Coca-Cola or--but you don't have anything in your mind about RC Cola because they've never been, you know. So we want that--we want that brand to be associated with something like the Olympics where there's happiness, where there's competition, where the nations are getting together. It's a venue we could not skip.
QUICK: There have been people in the past who have said, `Hey, these sponsorships get more and more expensive.' There are guerilla ways that other companies can kind of make their way in...
BUFFETT: Yeah.
QUICK: ...without paying. Is that an option for Coca-Cola down the road?
BUFFETT: No, I--Coca-Cola would never be going on a country road when the interstate's available. And it's--we're not--we're not there to be around the edges, we're there to be front and center.
QUICK: You know, Carl, we've been talking earlier in the week about what some of the Chinese media had been reporting about Buffett, about Bill Gates. What have people been saying?
QUINTANILLA: Well, I think--I think the Coke comments are interesting, Warren. We interviewed the chief marketing officer from Coke here last week, and of all the Olympic sponsors, right, the global sponsors, the GEs of the world, the Lenovos, in China the poll numbers show that they associate the Olympics the most of all the sponsors with Coke. So the marketing machine is obviously working. We did--we did talk earlier in the week back--maybe it was last week--about Pangu Plaza, the big hotel and office park...
QUICK: Right.
QUINTANILLA: ...and shopping mall that's over my shoulder here. And The Times did that story earlier in the week about whether or not Bill Gates had rented out a penthouse for a year, and whether or not Warren was staying there. Any truth to that at all, Warren?
BUFFETT: No, I'd actually talked about going to the Olympics a little bit with Bill, but I'm the kind of guy that has to have it explained to me on television what happened, you know, that I just saw. So I enjoy it enormously watching it on television, and Bill was over there for a week. Although the day or two before he went over he was playing at a bridge tournament in Omaha and then he came back to Omaha almost directly from the Olympics after about a week over there.
QUICK: So that wasn't you? You weren't--you weren't the one they spotted walking around in Beijing?
BUFFETT: No, that must be my double, George Clooney, actually that was spotted.
QUINTANILLA: Has--Warren, has the--have the games, in all seriousness, have the games made you think any differently about this part of the world--the world, western China, growth opportunities, the ability for American companies to operate effectively within a different government structure?
BUFFETT: Yeah, well, I was over there almost a year ago--Becky was with me--and I was blown away by what I saw. I'd been there--the time before that was 1995, and I really had never seen a country change so much in a--in a 12 or so year period, and clearly, when you think of the size of the country, to effect that sort of change. So I--no I've been a big believer in China before the Olympics and certainly they've put on a marvelous show during the Olympics. And--but I would have expected that. You get--you get a bunch of very, very bright people who care enormously about putting on a wonderful event, they're going to get the job done.
QUICK: What about Chinese stocks? Does--do those--does the stock market there interest you? You've been looking around the globe?
BUFFETT: Yeah, you know, you still can't buy stocks within China except under special circumstances.
QUICK: Right.
BUFFETT: But, yeah, I--we owned that PetroChina stock at one time. There's one other stock over there that we actually made a bid on here not so long ago, and it wasn't accepted. But it's a terrific--it's going to be a terrific area for business. So, under the right circumstances, you could see us with a lot of money there. [Buffett is a China bull.]
QUICK: What was the stock that you made the bid on?
BUFFETT: Oh, surprise, surprise. I never thought you'd ask.
QUINTANILLA: Nice, Beck.
BUFFETT: No, that--I have sort of a mind blankout after I learned...
QUICK: But it's not--it's not impossible to say that, yeah, you are continuing to look at stocks and you would make a bid from time to time if you found something that interested you.
BUFFETT: We made--we made a half a billion dollar bid on something, right.
QUICK: You made a half a billion dollar bid?
BUFFETT: Dollar bid, right.
QUICK: OK, if you don't remember the--if you don't remember the stock, what was the industry?
QUINTANILLA: Oh sure, now you tell us.
BUFFETT: Yeah, it's bigger than, yeah--you're good, but...
QUICK: But not that good. No dice on this one? All right, well, Carl...
BUFFETT: She thought she'd get me at 5 in the morning, folks, and I'd be punchy.
QUICK: Yes, and maybe you wouldn't quite be on the defensive just yet. But, Carl, we do have about two and a half more hours where we can try and work on him and squeeze more details out, so...
QUINTANILLA: Yeah, I've heard--I've heard that if you get enough cherry Cokes in him, he will spill everything.
QUICK: We've got them lined up.
BUFFETT: It acts like truth serum, yeah. There's no question about that.
QUICK: Yeah, well we've got those cherry Cokes lined up, and we'll keep them coming. All right, folks, coming up, we're going to go from Wall Street to Washington, as a new movie is out there creating some shock waves this morning. This movie is all about debt and why it could be putting the future of our country at risk. We'll get to the men behind the film who'll be joining us when SQUAWK BOX returns live from America's heartland.
US Debt, Inflation, Fannie Mae
QUICK: All right, welcome back, everybody. As we mentioned a little earlier, the movie "I.O.U.S.A." premiered across the country last night, and we got the chance to host a live town hall in Omaha that was simulcast to theaters across the country last night. Our CNBC team was on the ground at some of those theaters across the country. They got the chance to catch up with crowds from the East Coast to the West Coast. And, Warren, a lot of them heard you were going to be at this town hall meeting, and so we had our cameras ask some of those people some questions that they wanted to pose to you. Are you ready?
BUFFETT: I'm ready.
QUICK: All right. Let's get to some...
BUFFETT: Where's the popcorn?
QUICK: Oh, there--they didn't provide popcorn quite this early...
BUFFETT: All right.
QUICK: ...but we do have some questions that are coming up. Let's get to the first question for Mr. Buffett.
Unidentified Man #1: Do you think there's a characteristic about American democracy that leads to American debt?
QUICK: A characteristic about American democracy that leads to American debt. What do you think?
BUFFETT: Well, there's nothing inappropriate about having debt in America. I mean, Berkshire has debt, and it's helped us grow over time. And it's when debt gets out of control that you worry. But the American democracy, it's always fun to spend a little more than you take in, and that applies to individuals, it applies to governments. And in a $14 trillion economy, having debt that's 60-odd percent of GDP is not inappropriate. It wasn't inappropriate when we had 120 percent of GDP in debt after World War II, because we had to fight a war.
QUICK: Although you can't expect to maintain deficits like that endlessly.
BUFFETT: Yeah, you can expect to maintain a deficit that's a given percentage of the GDP. I mean, Berkshire can expect to have debt forever, and the larger we get in terms of our equity and earning power, the more debt we can sustain. And I don't think our shareholders would want us to operate--take on some rule where we're going to operate debt-free in the future. So it's--what you worry about is when the debt starts spiraling out of control, when it goes up year after year after year as a percentage of GDP, because eventually when that occurs people--if you try to borrow money around the world in your own currency, the world will say no. That's what happened in South America in the past, it happened in the--in the Asian arena. We are able to borrow money in dollars. The world trusts the dollar. If we tried to run our debt up to 3- or 400 percent of GDP, nobody would want debt denominated in dollars.
QUICK: OK. Let's take another question. This one comes from Irvine, California.
Unidentified Man #2: Hey, Mr. Buffett, I would like to know what is going to happen with Fannie Mae. Are they going under?
QUICK: That was, again, what would be the best investment to hedge against the upcoming debt crisis?
BUFFETT: Yeah. Well, I would say I don't think there's going to be an upcoming debt crisis, but if you believe that fiscal activities that the government will get out of control and that we will get on a situation where the debt skyrockets, you will have, obviously, you'll have inflation--significant inflation. No government likes to pay back its debt in dollars that are equivalent to the kind they took in. The best thing you're going to have is develop your own talent. I mean, if you're the best doctor in town, if you're the best teacher in town, if you're, you know, the best salesman in town, you'll do well no matter what the currency does.
QUICK: Mm-hmm.
BUFFETT: I mean, you will get your share. So investing in yourself is always the best thing. [Buffett wisdom: Always invest in yourself.] Now, second best thing is to own products or stocks that have products that don't require much capital investment, because you don't want to be--have a lot of required capital investment during inflation; where they have very little capital investment but they are sort of a royalty on whatever the current price level is in the country. [Buffett wisdom: Look for something with low capital investment.] I mean, if you take--I don't know what product you might buy regularly, but what--whatever you use for your hair or...
QUICK: (Unintelligible)
BUFFETT: You're not going to change that if the price level doubles.
QUICK: Right.
BUFFETT: And if they don't have to build new plants or anything, they just ride along that curve.
QUICK: OK. And very quickly, that Irvine, California, question, I think we heard the wrong one. The Irvine question, another one he was just asking about was what's going to happen with Fannie Mae? Are they going under?
BUFFETT: Well, in a sense they've gone under in that--in that they only are existing because the federal government has said that they're going to back up their obligations, so that...
QUICK: Right.
BUFFETT: ...from a standpoint of an independent entity, it--it's--the game is over on that, pretty much. And that does not mean the Fannie debt or the guarantee on Fannie mortgages is bad. Fannie Mae's an important institution in the--in the United States. But they priced risk wrong.
QUICK: Mm-hmm.
BUFFETT: They did some things in accounting that were bad, they tried to obtain goals that couldn't be achieved, and in the--and they leveraged up to an extent that was kind of crazy and certainly was crazy to do it with the assets that they were using the leverage for. So essentially the equity got wiped out.
QUICK: OK. We're going to take a quick break right now, but folks, when we come back we're going to talk about Warren and Bill's excellent adventure. We'll get the inside story of your summer expedition with Bill Gates. You just went this week to look at the tar sands.
BUFFETT: True.
QUICK: All right. We're going to talk about all of that when we come up, and we'll be checking in with questions from more viewers across the country, too.
Unidentified Man #3: I was very curious, in your recent 10-Q, that you had not purchased any bank stocks, very surprised that you had not jumped on that in July. I was wondering how low they have to go before you're interested.
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References:
- What Warren thinks...
- To von
- Buffett: "Recession will be Longer and Deeper"
- Nouriel Roubini
- Nouriel Roubini
- George Soros on Financial Crisis, Commodities, China
- Quick Comments
- Steinhardt: Stocks Will Extend Drop on Banks, Oil
- Writedowns May Reach $1.3 Trillion
- James Chanos
- Rogers: Fannie & Freddie, Oil, China
- Gross Says U.S. Will Rescue Fannie, Freddie (Transcript)
- Financial Weapon of Mass Destruction
- Tice: Another 5-Year Bear Markets
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