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Buffett Says US in Recession, Banks to Face Pain

Warren Buffett, the world's richest person, said on Sunday the U.S. economy is in recession, putting him at odds with a government report that showed weak growth.

Warren Buffett
CNBC.com
Warren Buffett

Buffett offered his assessment during a wide-ranging news conference, a day after a record 31,000 shareholders of Berkshire Hathaway attended the insurance and investment company's annual meeting in Omaha.

Last Wednesday, the Commerce Department said the economy grew at a 0.6 percent annual rate in the first quarter. But Buffett said the nation's population also grew, making the real growth rate lower. He also said that, even if the data do not show the economy retracting, people feel as though it is.

"The U.S. is in recession as I define it," Buffett said. "I would define that as a situation where people are doing less well than they were three months, six months or eight months earlier and most businesses find themselves in that position too.

"If were are in a non-recession, I don't think people want to see it going in the same direction as it is and saying it's wonderful."

Weakness at Berkshire units that sell bricks, carpets and other products dependent on a healthy housing market contributed to a 64 percent decline in overall first-quarter profit.

Housing remains a critical problem, he said, as hundreds of thousands of homeowners find their mortgage payments heading higher, or that their homes are worth less than they owe.

Buffett said he wrote U.S. Treasury Secretary Henry Paulson a letter in which he favored giving people taking out mortgages one-page statements, headlined "WARNING" in red, describing the maximum rates they could face.

While Buffett said the government could help borrowers who were misled on what they would owe, he opposed helping people simply because their home values have dropped, or investors who bought mortgage securities without understanding the risks.

Borrowers, he said, "shouldn't be penalized for being misled, but shouldn't be protected against mistakes."

He estimated that more than 80 percent of borrowers with "option" or "pick-a-payment" mortgages that let them pay less than the principal due, in fact did so, and that many now owe more than their homes' values. "Surprise, surprise," he added.

Bear Stearns A "Watershed"

Buffett said housing problems will weigh down bank results for "a couple of years" and the industry's large losses and write-downs due to bad debts are not over "by a long shot." "There's going to be more pain, sure," he said.

Yet Buffett said the U.S. Federal Reserve's brokering in March of JPMorgan's purchase of the nearly bankrupt investment bank Bear Stearns averted a "contagion," including possible runs on other investment banks.

"The idea of a financial panic ... has been pretty well taken care of," he said. "That was a watershed event."

But shareholders could still be hurt.

Alluding to a large stock offering last week by Citigroup , which lost close to $15 billion over the last two quarters, Buffett said: "Citigroup is replenishing its stock at $25 when it was buying it back not too long ago at $50. Many institutions not only grew the Kool-Aid, but drank it ... They paid a price, but the price was really paid by shareholders."

And Buffett said banks need better risk management. He said he recently considered the prospects of a large investment bank, which he did not identify, by reading its 270-page annual report. He said he highlighted 25 pages where he did not understand what he had read.

"I decided not to pick that one," Buffett added.

Heightened risk may also affect government-sponsored enterprises Fannie Mae and Freddie Mac . Buffett said the government "is asking (them) to take on more risk per mortgage and more (risk in) their portfolio. By any other standard of government operation, they wouldn't be able to borrow another dime."

Buying In Britain

Buffett, 77, said Berkshire still has three internal candidates to replace him eventually as chief executive officer, including one who would step in immediately, and four candidates to succeed him as chief investment officer. He has not publicly identified any of the candidates.

Since taking it over in 1965, Buffett has built Berkshire into a $207 billion conglomerate of about 76 operating units, and about $147 billion of stocks, bonds and cash.

On Sunday, Buffett said Berkshire may be "close" to buying a medium-sized British company and "will look" at Royal Bank of Scotland's insurance operations, including its Direct Line home and car insurance business. RBS said last month it may sell all or some insurance operations.

Buffett also said some bond insurers that rival his new Berkshire Hathaway Assurance Corp do not deserve their "triple-A" credit ratings. He said this may be one reason Berkshire, also rated triple-A, was able to capture $400 million of business in its first full quarter.

"The $400 million we wrote in the first quarter were entirely secondary market transactions," he said. "We see every day that people are coming to us and paying us more than they paid to the original bond insurer."

Investing in South Korea

Warren Buffett also added that Berkshire might invest more in South Korea, following a successful investment in the steelmaker POSCO.

"We certainly are comfortable investing in Korea, as evidenced by our Posco investment," and further investments in the country are "not inconceivable," Buffett said. "We like the ethos of Korea for shareholders and we like the performance of the businesses."

He also said "that stock market got about as cheap as any stock market I've seen in my lifetime in the period a couple of years before we bought in."

Charlie Munger, Berkshire's vice chairman, added at the news conference: "I think POSCO is the best steel company in the world and I think number two is a significant step behind."

Berkshire has said it ended 2007 with a $2.14 billion stake in POSCO, or 4.5 percent, for which it had paid $572 million.

Buffett added that Iscar Metalworking, an Israeli company that in 2006 sold an 80 percent stake to Berkshire for $4 billion, has a South Korean unit whose performance has been "just miraculous."