Monday, May 5, 2008

Buffett-Munger Speak About Financial Companies Deserving Pain

Berkshire executives say companies that created credit crunch deserve the pain they're feeling.

Billionaires Warren Buffett and Charlie Munger say the pain many financial institutions are feeling because of the credit crunch is well deserved. The chairman and vice chairman of Berkshire Hathaway Inc. said Sunday that the financial companies that engineered subprime mortgages and the investment funds backed by those mortgages don't deserve much sympathy as they record losses now.

Buffett said the current financial crisis is a byproduct of a system that encouraged executives to "paint pretty pictures." Munger said lots of financial institutions acted with stupidity and overreached to improve earnings in recent years. "I think you have to start with the idea that a lot of the current troubles are richly deserved," Munger said.

The complexity of the tactics that financial institutions often employ makes it difficult to determine what those companies are worth -- even for Buffett. "There are some financial institutions I can't value," Buffett said. He said if someone had $1 million to invest in 10 stocks, it would be easier to find good values in the Korean stock market than among U.S. banks because the banks are so complicated.

Buffett said he recently read a 270-page annual report that an investment bank filed with the Securities and Exchange Commission, and he had unanswered questions about 25 pages of the report. "They're cleaning up their act now to some degree because they had to," Buffett said.

Munger said he doesn't think investment banks spend enough time thinking about risk and ways to avoid it like he and Buffett do at Berkshire. "We try to behave as if Berkshire stock was all owned by crippled relatives," Munger said.

Buffett said the pain isn't over yet for financial institutions, but he said nobody can predict how many more times banks will have to write down the value of their assets. The largest U.S. bank, Citigroup Inc., alone has taken more than $45 billion of write-downs and credit losses since June 30.

Buffett and Munger spent nearly three hours answering reporters' questions Sunday at their only planned news conference of the year. It is one of the events surrounding Berkshire's annual shareholders meeting that attracted 31,000 people to Omaha on Saturday.

Buffett reiterated that he believes the U.S. economy is in a recession by his definition, even if it hasn't yet met the commonly used criteria of two quarters of negative growth. He said his definition of a recession is when most people and businesses are not doing as well as they were three, six or nine months ago. "I would say that we're in a recession clearly," Buffett said.

He said the Federal Reserve's bailout of Bear Stearns Cos. likely prevented a crisis among investment banks because Bear Stearns held a large number of derivative contracts with other investment banks. If Bear Stearns went bankrupt, all those derivatives would have to be valued at zero or unloaded quickly.

But he and Munger agreed that not every business or investment bank should be rescued, because failure is an important part of capitalism. "Capitalism without failure is like Christianity without hell," Buffett said.

Lenders and investors who were dumb enough to deal in subprime mortgages should not receive any special help, Buffett said, but if homeowners were deceived about the terms of an adjustable mortgages, they should be helped. "People make mistakes in capitalism," Buffett said. "They shouldn't be penalized for being misled, but they shouldn't be protected from mistakes."

Buffett said the mortgage mess grew partly out of the belief many people had that their homes would always increase in value. And he said many of the mortgages that are in trouble are ones with which owners refinanced and took out more cash than they'd ever paid for the home.

Those homeowners and lenders were all counting on tomorrow's home prices to bail them out of today's decision. "People tend to forget how well the system worked when we had rules that prevented this complexity and aggression," Munger said.

Berkshire owns more than 60 companies including insurance, clothing, furniture, jewelry and candy companies, restaurants, natural gas and corporate jet firms and has major investments in such companies as Coca-Cola Co., Anheuser-Busch Cos. and Wells Fargo & Co.

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