THIS IS THE SEVENTH PART OF A TRANSCRIPT OF WARREN BUFFETT'S SERIES OF LIVE APPEARANCES THIS MORNING (MONDAY, MARCH 3) ON CNBC'S SQUAWK BOX.
KERNEN: Welcome back to SQUAWK BOX here on CNBC, first in business worldwide. I'm Joe Kernen, along with Carl Quintanilla and Becky Quick, who's in Omaha this morning with the man himself, Warren Buffett. It's a perfect day to have him on with everything going on in the markets and the economy. Becky, I don't know if you've gotten access to the wire services, but they truly...
QUICK: I don't.
KERNEN: Well, they truly are hanging on every word. I mean, I'll see a flash, you know, the ones you would think of: Buffett, common sense, we're in a recession. But also, Buffett says he has not--a woman is not on the list for CIO. They have another one that says Buffett would not put Obama or Clinton in charge of Berkshire. So they're putting everything on there. Nothing about me being the main guy for CIO, though. Nothing about Joe being in the--in the...
QUINTANILLA: One of the four candidates.
KERNEN: And I challenge Reuters and Dow Jones to, if he said it--they're putting everything else on. J-O-E, right?
KERNEN: Even just my first name is OK. I'm mad.
QUICK: And Joe, did they pick up--did they pick up what he puts on his hamburgers? The mayo and ketchup?
QUINTANILLA: That also has not been on the wires.
KERNEN: That has not been picked up, either. It's like, you know, they're trying to judge what's important and what isn't and, you know, someone--they're like 22 years old, they're misspelling everything. But--no, they're not. They're...
BUFFETT: I'm doing my best to make news, but...
KERNEN: You are--you are making a lot of news.
QUINTANILLA: Yes, you are.
KERNEN: And I got so many follow-ups, Beck, but let's get to--there--you know, earlier it was quiet. There are so many e-mails at this point that have come in, I'm sure they're very similar to the ones that you already have ready to go. So you want to take it away, Beck, and do some more?
QUICK: Sure. And guys, jump in as you want. You know, you tell us when you want in on these things, and...
KERNEN: We want in at--we want in whenever you can let us.
QUICK: ...it's hard when we're far apart, but you guys jump right in.
KERNEN: Yeah, we want in whenever...
QUICK: All right, you guys jump in. You guys are listening. You hear any points you want to jump in on, go right ahead because...
QUICK: ...we're OK with this. We're working. We can hear everything.
QUICK: But we're going to start off with a question about derivatives, because Joe, you brought this up earlier. You were talking about those comments that Mr. Buffett's made in the past about these being weapons of financial mass destruction. And Warren, you said you had a couple other thoughts on derivatives.
BUFFETT: Well, you know, the ways you get into trouble in markets is doing things you don't understand, and then doing them with a lot of borrowed money. And derivatives combine those things. And--but the really important illustration that has never gotten picked up on much was that a couple of years ago Freddie and Fannie got into big trouble, billions and billions and billions of dollars of--that they had to restate. Now, Freddie and Fannie had auditors like everybody else, but they also had a government agency called OFHEO that had 200 people in it whose sole job was to oversee Freddie and Fannie. Two hundred people going to work every day, and those people did not pick up at all on all of these problems that Freddie and Fannie had. I mean, they were looking at complex financial instruments, you know, all kinds of swaptions and all that sort of thing. The auditors didn't pick up on it, but more important, 200 full-time--they didn't have to think about General Motors, they didn't have to think about AT&T. They had two companies to think about. And they issued a report later on telling about the failing of all--everybody else.
BUFFETT: But it shows you--when things get that complex, you're going to have a lot of problems. And CDO squared--I figured out, on a CDO squared you had to read 750,000 pages to understand the instruments that were underneath it.
QUICK: Oh, my gosh.
BUFFETT: Yeah. Well, you start with the RMB, that's the residential mortgage-backed securities, and that would have 30 tranches. And then you'd take--and that would be a 300-page document--you'd take a tranche from each one of that and create a CDO, 50 of those times three--300, you know, it becomes 15,000. Then you take a CDO squared with 50 more, and now you're up to 750,000 pages. QUICK: You have to read through it.
BUFFETT: And the mind can't comprehend that. What people did comprehend was that the fees were terrific in selling them to the people.
QUICK: Yeah. It raises some questions, too, when you talk about people who are looking at oversight for these very particular things, about what's been happening with the rating agencies as well, and there's been some viewer e-mail. I'd like to bring in another one right here. In fact, Brad Osterloo from Mitchell, South Dakota, writes in and says, `I was surprised to see no mention of the municipal bond rating crisis nor a mention of Berkshire entering that market in the annual report--how come?'
BUFFETT: Well, we entered it very late. I write--I write the report in November, December, we didn't even enter in the--and we're still very small in it. We'll undoubtedly have something to say about it at the annual meeting and in the report next year. But, you know, as I mentioned, we only have had 69 million of premiums. We've written 206 contracts so far. So it's something we've just started in. We were admitted in New York about a month ago, we've been admitted in five more states. The states have been terrific about responding very quickly. But we got into Maryland the other day, so it's moving, but it isn't yet a big item.
QUICK: OK. Joe:
KERNEN: You know, Warren, I was--your comments about insurance, the party being over, I don't think you were talking about monoline. And typically property casualty, P and C companies, there's these big macrocycles that have to do with--I don't know whether there were a lot of disasters in one year, and being able to raise premiums. What are your thoughts on what makes it such a difficult time right now for the entire insurance industry? Why did you say that, that the party's over? Because of the credit crisis?
BUFFETT: Well, it's been a--it's been a--it's been a--no. It's been a wonderful time up to now. Now, if they happen to own the wrong assets, they could lose some money on that. But on their peer insurance underwriting, we've had two very, very good years, partly because rates were very good and partly because natural disasters in the United States were almost absent on a big scale. So we're now going into a year where rates will be somewhat lower. Exposures grow every year, and some years we'll be lucky on natural disasters and some years we won't. But I would bet a lot of money that the--that the underwriting profit margin--or loss, perhaps--but underwriting profit margin of the US property casualty industry decreases in 2008, but it's decreasing from a very good level. So it--but it's going to be worse.
QUINTANILLA: Warren, we've talked a lot about growth concerns this morning, inflation concerns. Page two of the Journal, Greg Ip, big Fed watcher, has a story about how for the Fed it is recession, not inflation, that poses the greater threat. If you were in the chair, and Chairman Buffett was giving Humphrey-Hawkins on the Hill, would you be framing it the same way?
BUFFETT: I'd probably arrange to get an emergency call so I had to leave the place. Hey, it's a very tough position. I never--I don't like to second guess Fed chairmen, because they have a very, very tough problem. They don't--and they don't have all the answers. They know they don't all have the answers. And, of course, people like to think they do. And the problem with inflation is that it's very easy to ignite it and it's very hard to put it out. And you needed a Paul Volcker to do it 25 years ago. So I think Bernanke's got a very tough balancing act and I think there's a pretty fair chance that the country will react in such a way as to ignite inflation in a serious way.
QUINTANILLA: I don't want to put words in your mouth, but one could take that and say, `Well, Buffett's suggesting they're on the wrong side of the trade.'
CNBC has scheduled a one-hour special program on Buffett's unprecedented Squawk Box appearences.
It's called Warren Buffett - The Billionaire Next Door: Face to Face. It will be hosted by Becky Quick and airs tonight, Monday, March 3 at 9pm ET.
BUFFETT: No. The trouble is they have--they've got a problem on the other side. You know, it's like Woody Allen in that movie many years ago, where he said, you know, `We face a fork in the road. One leads to death and pestilence and the other leads to total destruction. May God grant us the wisdom to make the right choice.' I mean, it is not an--it's not an easy game.
KERNEN: I was thinking of Yogi. `If you get to a fork in the road, you should take it' is what--that was much--that was much easier one to...
BUFFETT: Yeah, absolutely take it. Yeah.
KERNEN: Warren, real quickly on--I wanted to follow up, a long time ago, on your comments about hedge funds. I don't know the exact numbers, but let's say 10, 12 years ago there were X hedge funds, now let's say that there's 50 X, or whatever it is. And you're not a big fan, obviously. How do you foresee the scenario where we go back to something between X and 50 X? Does the market--does a bad market take us there? Does bad performance across the board take us there? How do we see the end of this--of this explosion in hedge fund mania?
BUFFETT: Over time there will be a disillusionment when the--and incidentally, it won't be disastrous or anything of the sort. There'll be--there'll be the occasional blowups here and there. But over time, when people find out that it's not the holy grail, you know, the money will flow elsewhere. You know, people will--people always go through the rearview mirror, what's been popular and has worked recently, and this will be like all the rest.
QUICK: You know, Warren, in your annual letter you laid out an argument not only against companies and how they're not really thinking correctly about their pension right now, the pension plans and how they're funding them, but you also said that the public sector faces a much bigger problem; that municipalities are even in a worse situation, because they're promising people they can retire in their 40s and different things, making promises that they're never going to be able to keep.
QUICK: Floyd Norris over the weekend, of The New York Times, pointed out yes, but at the same time you're very willing to underwrite a lot of those same municipalities for the promises they're making right now. Why is that?
BUFFETT: Well, that could be a tough problem. I mean, they won't walk--they won't walk away from the pension problems. It's going to be easier to walk away from their bonds than it would be their pension problems. But it's a--it's an incremental problem. And it's so easy, if you come up for election next year, to increase pension promises. You know it'll get you votes and you don't--you're never have to--going to have to pay if you're on the city council or if you're a governor or a state legislator. So those promises--you know, when I was in New York, I knew some guys that retired in their early 40s and they worked a lot of extra hours in the last year and all of that. And they were going to be getting pensions for 40 or 50 years. So they worked for 20 years and they're going to get paid 40 or 50 years for not working. And that creates a lot of problems on their own. And it's much more so in the--in the public sector than it is with corporations.
QUICK: OK. Another viewer e-mail here, a gentleman named Bo Mann writes in. He says, `You usually advise the younger crowd. But what would an ideal portfolio consist of for a 55-year-old man with two kids entering college and $1 million to invest? Should it be 100 percent Berkshire?' That's what he asks, not me.
BUFFETT: I'm only 99 percent Berkshire myself, so I never go 100 percent. Well, I think if you buy equities across the board, which means an index fund, and if you do it over time so that you don't put all your money at the wrong time, and it's a low cost index fund, that's probably the best investment that most people could make. Mm-hmm.
QUICK: OK. Now, Carl and Joe, we will get back to you guys in the studio. Again, we'll be here--and I should point out, we are at the Nebraska Furniture Mart right now in Omaha. You wonder why we're sitting in the middle of a store. This is one of Berkshire Hathaway's many companies and this store that we're sitting in right now is one that they just redid this year and opened up this brand-new store. So if you wonder why we're sitting in the middle of a store, that's why. And we'll get to a lot more questions with the Oracle coming up.
QUINTANILLA: That's a great shot, Beck. We'll see you in a couple of minutes.
Transcript prepared by BurrellesLuce
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