TRANSCRIPT/VIDEO PART ONE: Three Hours With Warren Buffett - Live From Omaha

THIS IS PART ONE OF "THREE HOURS WITH WARREN BUFFETT - LIVE FROM OMAHA" ON CNBC'S SQUAWK BOX WITH BECKY QUICK, FRIDAY, AUGUST 22, 2008.

IT IS AN UNEDITED TRANSCRIPT AS PROVIDED BY BURRELLESLUCE.

BECKY QUICK: Good morning, everybody and welcome to SQUAWK BOX right here on CNBC. This morning we have quite a show in store for you coming up today. As you probably know, our special guest for the next three hours is a man who needs no introduction. We are talking about Warren Buffett. And, Warren, good morning. Thank you for joining us this morning.

WARREN BUFFETT (Berkshire Hathaway Chairman & CEO): Yeah, early morning, right.

QUICK: Very early morning. You've only had a couple of complaints about that, right?

BUFFETT: No, I try not to complain too much.

QUICK: Well, good morning. Thank you for joining us today. We have an awful lot to talk about this morning. Also, this is a worldwide, around-the-world show this morning. From the world's most famous investor, we're being--going to be going to the world's most celebrated athletes. Carl, you know, the Summer Games are coming to a close. You've been there covering the whole thing and what are your feelings as we get to this final end of the entire Olympic Games?

CARL QUINTANILLA, co-anchor (Beijing): I was just going to say, Becky, this has got to be the first ever broadcast of split anchor Beijing-Omaha show in the history of television. We've got a lot going on here. We've had--we've had pretty good success, the Americans winning gold in soccer, beach volleyball, going for the gold in volleyball. We'll bring you up to speed on all the Olympic action. But as we're closing down here, into the closing ceremony on Sunday night, we're just beginning an amazing three hours with Warren. Warren, it's great to have you.

BUFFETT: Nice to be here.

QUICK: You know, we were--we were joking about that this morning with Ross that we are now trying to make SQUAWK look just like "World Wide Exchange." We're going to be picking new places around the globe and doing this from time to time. Right, Carl?

QUINTANILLA: That's--exactly. And if the satellite delay gets any worse, we could have entire blocks of the show in which we're just waiting for the other to respond.

QUICK: All right. That sounds perfect. You know, Carl, we're going to check back in with you in just a few minutes because we have a lot of things about the Olympics to talk about with Warren Buffett as well, everything from Coca-Cola to sponsorships. But, folks, we are in Omaha today because last night there was a groundbreaking event in the world of finance and politics that took place right here. It was the world premiere of a documentary called "I.O.U.S.A." Now, the film takes a look at what it says are America's four key deficits. It explores the risks to the future of this country and of its citizens. And, Warren, you were in the documentary, so let's take a look at one of the clips from that right now.

BUFFETT: Yes.

(Clip of "I.O.U.S.A." courtesy Roadside Attractions)

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.

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. 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.

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?