Warren Buffett Watch

THIS IS PART SIX 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.

GO TO PART ONE, PART TWO, PART THREE,  PART FOUR, OR PART FIVE OF THE TRANSCRIPT

Announcer: This is a special edition of SQUAWK BOX live from the Holland Performing Arts Center in the heart of beautiful Omaha, Nebraska. Now, once again, here's Warren Buffett and Becky Quick.

BECKY QUICK, co-anchor (Omaha, Nebraska): Welcome back, everyone, to SQUAWK BOX here on CNBC, first in business worldwide. We are just one hour away from the opening bell right now. Again, we've been watching the futures higher through the morning. We've been spending a lot of time this morning with Warren Buffett and he's been answering questions from followers across the country. If you see right now, the Dow futures are, in fact, close to 100 points above fair value, but let's head back to California to get a question of--from one of you at home.

Unidentified Man #1: What are the odds that we could have a bank failure similar to the 1929 era?

QUICK: Warren, that question was, again, what are the odds that we could have a bank failure similar to what we saw in 1929?

WARREN BUFFETT (Berkshire Hathaway CEO): Well, that's quite unlikely, partly because of the FDIC. People--you had failures in the Great Depression where the failure of Bank A caused the failure of Bank B. When they saw a line at Bank A, everybody lined up at Bank B and then they lined up at Bank C. And the FDIC was one of the great ideas of the Depression. You've got terrific woman, Sheila Bair, running that. So we won't see failures simply because there's a wave of failures elsewhere. What we'll see here are failures where the banks were dumb in what they did and you will see a fair number of those. We had a huge number of bank failures in this Midwest area, including Nebraska, in the early 1980s when there was a farm bubble. Where there's been a real estate bubble and the bankers have participated big time, you'll see some bank failures, but you will not see any losses to anybody that--in terms of FDIC covered accounts of 100,000 or under, so nobody needs to worry about their $80,000 account at any bank, even though the bank may have been run in a dumb way.

QUICK: Although you've said it before that the financial system is much more intertwined and linked than it had been in the past, especially when you start looking at some of the investment banks and beyond. Do you worry about that?

BUFFETT: Well, that's why the Fed had to rush in on Bear Stearns.

QUICK: Right.

BUFFETT: I mean, they weren't--they weren't worried about Bear Stearns, they were worried about the consequences of Bear Stearns toppling and then the domino action following, which would've happened in my view. I think they made exactly the right decision. There's enormous interconnection and derivatives have accentuated that in a big way so that trouble spread. And even if you made sound loans getting 10 or 20 percent down, if the other guy made a bunch of dumb loans and that causes a huge supply of houses and house prices, appreciation, and even the better loans can get impaired to some degree. So nobody gets insulated from the problems of the economy. And if you're a bank, you feel some of those effects no matter how prudent you've been over time. But there's not going to be a wise--there's not going to be bank failures happening just because there's other banks fail.

QUICK: Could there be another Bear Stearns this time around, though?

BUFFETT: Sure. People--and I've said that you only find out who's been swimming naked when the tide goes out.

QUICK: Mm-hmm.

BUFFETT: Well, Wall Street has turned out to be a nudist beach. I mean, there's--there've been plenty of people that pushed balance sheets extremely hard. I mean, there was virtually no limit on credit. People, anything was going in the credit market and they were mispricing credit, they were--they were overleveraging and now the truth comes out as people start looking with, you know, some care at what's really on the liability side and the asset side of these banks. A long time ago there was a movie producer holding an annual meeting and one of his shareholders said in the film, you know, `I don't understand all these figures, Mr. Scurus,' or whatever his name was. `What do they mean?' And the CEO said, `Well,' he said, `I don't really understand them very well, either.' But he said, `But I can tell you this, the liabilities are good.' Well, that's what you find out in a period like this. The assets may not be so hot, but the liabilities are good and then that's when the trouble begins.

QUICK: When people start looking around to find the next potential Bear Stearns, Lehman Brothers is the name that comes up again and again. Should people be concerned about what's happening at Lehman?

BUFFETT: I don't think it's appropriate, really, to talk about financials.

QUICK: Financials, in particular, banks.

BUFFETT: No. I think that--I really think that's inappropriate to talk about them.

QUICK: Do you think that's caused...

BUFFETT: I have no problem talking about Fannie and Freddie because the government stands behind them.

QUICK: Do you think that's part of what caused the problems with Bear Stearns, though? Once the rumors get out, once the media picks up on it, once the names came back again and again? Is that...

BUFFETT: If you had a $400 billion balance sheet and 400 or so billion of stated equity underneath it, that means that you're dependent on the kindness of strangers every day.

QUICK: Mm-hmm.

Dave Grogan / CNBC

BUFFETT: And you know, it--if the strangers aren't there, you don't have a way of paying back the 400 billion. And so if your name is bandied--if you--in the case of the kindness of strangers, if your virtue is questioned, you know, you've got a problem. And there is no bank, investment bank, that can pay all its liabilities tomorrow, and if people present those liabilities and say we don't want to have anything to do with you, even if you offer us a little more on the repos or something of the sort, the game is over and it's a--I think Jamie Dimon said, you know, `Anybody who spreads rumors about financial institutions ought to be--ought to be put in jail.' It's--you can cause trouble. If I were to say XYZ is in trouble, they are in trouble.

QUICK: Right.

BUFFETT: I mean, you create your own fire in this case.

QUICK: Do you agree with Jamie Dimon that people should be going after the people who are spreading rumors about these financial institutions?

BUFFETT: It's hard to do. I mean, to find out where a rumor starts or anything. But I mean, it is--it's very serious business to question the integrity of a financial institution when you can't possibly pay all your liabilities the next day or the next week. And a rung--or a question creates its own dynamic and you can do a lot of harm to a financial institutions just by spreading rumors. So there ought to be penalties attached.

QUICK: I know it's hard to prove, but would your gut tell you that that's partially what happened with Bear Stearns?

BUFFETT: Well, it's partially, but there--it isn't the whole story, but Bear Stearns, you know, they had problems and their balance sheet was too big and the assets were too illiquid and--but the rumors moved it along. I mean, and it comes like that.

QUICK: Mm-hmm.

BUFFETT: You know, I ran Salomon in 1991 for a little while and we could've been put out of business. As it was, our balance sheet was shrinking every day. There was a lot of pressure. But one big story in the paper that says, you know, Salomon did go out of business tomorrow or something of the sort would have meant we would have gone out of business. I mean, everybody would have pulled their lines from us.

QUICK: OK. OK. Warren, we're going to have a lot more coming up. We've got more questions from people back home and we've got more questions from right here as well. Again, folks, if you are just joining us we, are live with Warren Buffett from Omaha, Nebraska. We'll have more SQUAWK right after this.

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