Warren Buffett defended Goldman Sachs as it faces SEC fraud accusations and talked about the signs of "real strength" he's seeing in the U.S. economy during a live interview in Omaha today, May 3, 2010 with Becky Quick on CNBC's Squawk Box. 

It was his first live TV appearance after answering shareholders' questions for almost five hours at this weekend's Berkshire Hathaway annual meeting.

Here are video clips and a transcript of their conversation.

BECKY QUICK:  Our guest host for the next hour is Warren Buffett.  He's the Berkshire Hathaway chairman and CEO.  And, Mr. Buffet, thank you for joining us this morning.

WARREN BUFFETT:  It's a real pleasure.

BECKY:  Did you hear this conversation about Goldman Sachs?

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BUFFETT:  I did, yeah.

BECKY:  Now, Goldman was obviously one of the huge headlines here this weekend.  There are -- right now the SEC considering these charges.  And a lot of concern about whether Goldman not only followed the letter of the law, but the spirit of the law.  What do you think?

BUFFETT:  Well, from everything I've seen of the Abacus transaction, which was the one the SEC put out the complaint on, I do not see a problem with that transaction.  We're a bond insurer, ACA was a bond insurer, MBIA, FGIC, Ambac, and all those companies started out insuring municipal bonds and then the profit margins got squeezed in the municipal bonds and they started drifting over and insuring other structured deals and so on. 

ACA had probably dozens of people analyzing bonds.  Many of the reports don't even explain that they were bond insured, but that was their job.  Their job was to look at credits and stick a proper premium on if they wanted to insure them.  If they didn't know what the proper premium was, they should have skipped insuring them.  And almost all of the bond insurers got in trouble during that period because they drifted over into areas where they really weren't that good.

BECKY:  But the SEC complaint focuses on fraud and says in large part it's because Goldman, the SEC alleges, did not let on that John Paulson was on the short side, betting against this, and he was helping structure the deal.

BUFFETT:  Becky, we had many deals presented to us.  But, for example, there was a municipal bond deal that was presented to Berkshire.  And 8 billion of municipal bonds and a Wall Street house came to us and they said, "We'd like you to insure these bonds."  And we said, "We'll do it for $160 million."  And you'll see that the state of California is a couple of hundred million and Texas is a billion.  And when that firm came to us, it happened to be Lehman Brothers two years ago, and we were to insure these bonds for 10 years.  There were four possibilities.  Lehman had these bonds and was hedging them.  Lehman had an opinion that municipal bonds were overpriced and they were shorting them.  They had a customer on the bonds that was hedging them, or the customers were shorting them. 

We didn't care.  Our job was to decide whether to insure the bonds.  I never asked who was on the other side of the transaction.  Obviously, somebody is on the other side of the transaction.  But if Ben Bernanke was on the other side of the transaction, I still would have insured the bonds.  It was my job to figure out what I wanted to insure.  And there's always somebody on the other side of the transaction.  And John Paulson could have been on the other side of that transaction and we still would have insured the bonds. 

On the other hand, if the premium was wrong, we wouldn't have insured the bonds.  So a bond insurer runs the risk of loss when they insure bonds.  It shouldn't make any difference to them who owns them, who is hedging them, who is shorting them.  They should decide what the risk is and charge an appropriate premium.  And ACA charged the wrong premium.

BECKY:  Lloyd Blankfein went before senators last week and a lot of them made it sound like he had intentionally misled his customers, told them one thing and then acted another way.

BUFFETT:  Well, I've been doing business with Goldman for 44 years.  They have raised a lot of capital for us that enabled us to deploy a lot of people.  They have been involved in more acquisitions than any other Wall Street firm by far in connection with Berkshire.  We're a much larger company because of Goldman Sachs.  And we trade with them. 

Now, I don't hire them for investment advice or services.  People do.  They have got a big investment advisory business, but I don't pay them for that.  What I do do is frequently is I trade with them.  When I buy something from them, they may be selling it for a customer.  They may be shorting it to me.  You know, it's not their responsibility to manage my money.  I could hire them to manage my money, if I want to.  But I don't.  And I often buy something from them that my guess is that they are shorting to me.  But, you know, that's the name of the game.

BECKY:  Melissa Lee mentioned that talk is growing that Lloyd Blankfein may end up losing his job over this.  What do you think about how Lloyd Blankfein has performed?

BUFFETT:  I think Lloyd Blankfein has done a great job of leading Goldman Sachs.  I mean, I have known the people who run Goldman Sachs ever since Gus Levy, every one of them.  And Goldman has had a history of picking first class people to run the business, people that are the sort of people that, you know, feel fine about having marry your daughter and people who are plenty smart about running a business.

BECKY:  Some people would say you are defending Goldman Sachs because you have a major investment with them.  You're talking your book.  What do you say to them?

BUFFETT:  Well, I'd say you're asking me the questions and I'm responding to your questions.  But I am talking my belief.  And we do have a major investment in them.  And if you put $5 billion in a company, you ought to feel pretty good about it and we felt pretty good about it when we did it.  And we feel pretty good about it now.

BECKY:  Do you think Lloyd Blankfein should continue in his job?

BUFFETT:  Absolutely.  Absolutely.  I'd rather have him running it than anybody else.

BECKY:  Have you had conversations with him this, about the transaction, about the SEC complaint, about what he needs to be doing in response?

BUFFETT:  Probably had three or four conversations, each one of them maybe five to ten minutes.  He's bringing me up-to-date on some development.  And he's asked me whether I've got any great ideas on this in terms of how to handle essentially what is a tsunami of press opinion.  But I have had no conversation with him in any way about him stepping down.  And if he asked me, which he hasn't, I would say by all means stay.

BECKY:  You mentioned on Saturday that of the 40,000 expected shareholders, probably 39,900 of them did not understand this transaction or what was happening at Goldman.  Do you think you were able to help them understand it this weekend?

BUFFETT:  I have been told by a lot of them.  I mean, I have literally had, dozens including some of our directors.  And they said they had never heard the transaction explained.  ABN AMRO actually is the one that ended up paying the dollars out.  ABN AMRO, now part of Royal Bank of Scotland, they paid out 900 million, or close to it, and got paid -- they paid out because they were a credit guarantor of ACA.  They took on that risk.  We sometimes guarantee the credit of other people.  ABN AMRO got -- it's in the SEC complaint, they got paid 17 basis points, that's about a million six, to guarantee 900 million of credit.  If ACA hadn't gotten in trouble they would have pocketed a million six and felt like they made a good deal.  But sometimes banks lose money guaranteeing credit and sometimes they don't.  ABN AMRO lost that money.  ACA originally lost the money because they rolled bond insurance on something they didn't understand very well. 

But bear in mind, MBIA was writing insurance like that at the time.  Ambac was writing insurance like that at the time.  FSA was writing insurance like that at the time.  And all of them lost money on it.  I mean, the housing situation in February of 2008 looked a lot different than the housing situation a year earlier.  And many people were wrong, including Fannie Mae, Freddie Mac, you know, companies with huge involvements with the society, managed by Congress essentially through an agency that had 200 people overseeing them.  And they were the biggest losers of all.  So a lot of people were wrong about housing.

BECKY:  Do you think this is a situation where it's some big banks that made some bad bets and now it's sour grapes?

BUFFETT:  Well, big banks made bad bets.  And lots of people made bad bets.  The American people made a bad bet on housing.  I mean, you know, at the peak, housing was worth 22 billion and people thought housing could do nothing but go up.  And everybody virtually believed it.  I mean, I believed it, you know, people in my block believed it.  Rating agencies believed it, Freddie and Fannie believed it, Congress believed it, Wall Street believed it, mortgage bankers believed it.  Housing had kept going up and up and up, so they built these models in their minds.  They might not have thought of them as models, but they basically didn't think housing prices could get cracked a lot.  And when they did get cracked, a lot of people looked awfully foolish and a lot of people lost money.

BECKY:  Do you think we have -- I guess the biggest problem with the Goldman situation with that back at Abacus deal is that the taxpayers eventually ended up paying for it because ABN AMRO may have made the bad bet but essentially at one point between that and ACA, it was soaked up by taxpayer dollars.  And that's what has people so angry.

BUFFETT:  Well, the biggest taxpayer loss apparently is Fannie and Freddie, and they were supervised by Congress.  And as a matter of fact, they reported to Sarbanes and Oxley, of all the irony.  So that's where the big money was lost.  But banks can lose money on loans that are guaranteeing credits.  They make decisions that sometimes are wrong initially and sometimes events make them wrong, as they turn out. 

But this transaction was not unique in any way.  A lot of people bet on the bullish side of housing.  There weren't many people on the bearish side.  And John Paulson was not regarded as a genius in 2007.  But if John Paulson came to me with a deal today to insure, I would look at what I was being asked to insure, and if I thought I understood it, I would quote him a price and if he took it, he'd have an insurance policy.  I don't worry about doing business with John Paulson.

BECKY:  Okay.  Joe, you have a question as well?

JOE KERNEN:  Just listening to Warren.  Hi, Warren, thank you for joining us today. 

BUFFETT:  Hi, Joe.

JOE:  But listening to the way you explained it, the American -- really, we were all  long on housing.  And with the benefit of hindsight, to see the way it's been portrayed not only in the media, but I know you probably saw those Senate hearings.  And you've been around a while, Warren.  You know the ways of Washington.  But when do you decide that Washington really is a bigger part of the problem than the problem itself?  And where this -- you know, if you really beat up on Wall Street and not beat up on Goldman, beat up on capitalism and beat up on the free market, should we just write it off to, ah, that's just the politicians? 

I have one here.  Senator Kit Bond, maybe you can weigh in, too.  They can eventually do some real damage, can't they, Warren?  That was a travesty and a witch-hunt and an inquisition.  Were you uncomfortable?

BUFFETT:  Well, it wasn't anything unexpected.  I mean when something goes wrong on a very, very major scale and lots of people participated in it.  I mean the whole country was involved in essentially what turned out to be a fantasy.  Now, we all believed it, we all want houses.  And it was very easy to say if houses are going to go up every year, you better buy it this year because it will cost you more next year.  And that became kind of a self-fulfilling mania for a while.  Because housing became 22 trillion out of the American public's 50 to 60 trillion of wealth and it was the one that you can margin the most, borrow the most against, you know, when the crash came, it really had consequences and nobody likes to say, "It's my fault."

JOE:  Guess we have to go to break, Beck.  And then we'll continue along, I guess, some of this stuff, right?

BECKY:  That's right.  And we'll let Senator Bond jump in on that as well and get his response.  We're going to sneak a quick break right now.  But as Joe mentioned, we have a lot more to cover with Warren Buffett.  We have got 45 more minutes.  We're going to be talking about whether the consumer is back in full force, what he's seeing and other signs in the economy, plus we've got a run-down of the morning's top stories.  So stay right here.  "Squawk Box" will be right back.

[COMMERCIAL BREAK]

BECKY:  We are back in Omaha.  And we've been talking about what happened with the housing crisis, who was to blame, with Warren Buffett, who is the chairman and CEO of Berkshire Hathaway. 

And, Warren, you were just getting ready to talk a little bit about who is to blame and whether the politicians were to blame as well.  I thought maybe you could say that and we could bring Senator Bond in as well.

BUFFETT:  Well, when there's a delusion, a mass delusion, you can say everybody is to blame.  I mean, you can say I should have spotted it, you can say the feds should have spotted it, you can say the mortgage brokers should have, Wall Street should have spotted it and blown the whistle.  I'm not sure if they had blown the whistle how much good it would have done.  People were having so much fun.  And it's a little bit like Cinderella at the ball.  People may have some feeling that at midnight it's going to turn to pumpkin and mice, but it's so darn much fun, you know, when the wine is flowing and the guys get better looking all the time and the music sounds better and you think you'll leave at five of twelve and all of a sudden you look up and you see there are no clocks on the wall and bingo, you know.  It does turn to pumpkins and mice.

BECKY:  Go ahead.

BUFFETT:  It's hard to blame the band.  It's hard to blame the guy you're dancing with.  There's plenty of blame to go around.

BECKY:  And alcohol.

BUFFETT:  There's no villain.

BECKY:  Well, let's talk about what Washington is doing right now with financial regulatory reform.  Are the issues that are on the table things that can prevent this from happening again?

BUFFETT:  Well, they can't prevent bubbles from happening again.  People do that.  The human beings go to extreme and when your neighbor makes a lot of money doing something, you know, you feel like you ought to be doing the same thing, too.  And they do feed on themselves periodically, whether it's the Internet boom.  You have had it all.  You had two bubbles, you know, 400 years ago.  You had South Sea bubbles.  So people will get delusionary from time to time. 

And you might say it's the job of the government or the Fed to try to talk them down or something of the sort.  It's not very effective.  If people really see easy money being made by someone else that they think is dumber than they are, it gets very tempting to be out there trying to do it yourself. 

So bubbles will happen again.  What you want to try and do is contain the damage from them.  And, you know, we did that after 1929.  Now, after 1929, we decided that people buying stocks on 10 percent margin was dangerous for the economy and we passed a law that said the feds should set margin requirements.  And then what did we do in 1982?  We validated an S&P 500 contract which let people gamble in untold numbers on tiny margins, all the while maintaining 50 percent margins with the Fed.  It was crazy.  But we took -- we took the safety net of high -- of high margins away from the stock market and nobody said a word.

BECKY:  So you're in favor of limiting some derivatives trading?

BUFFETT:  I'm in favor of having leverage limited with organizations that can produce dangerous for the system.  And I actually think leverage ought to be -- extreme leverage ought to be prevented for individuals speculating in the market.  We decided that was dangerous back in 1934 and I still think it's dangerous and we totally negated the benefit of that legislation when we let the S&P 500 and the derivatives come in to the game bigtime. 

I wrote a letter to Congressman Dingell in 1982, saying this would turn the market into more of a casino.  And there were plenty of people that said, yeah, but it's more fun having a casino.

BECKY:  The idea of limiting leverage for investment banks is a good one.  But then when you have all of these off-balance sheet transactions, it's very difficult to know how what the real leverage is.  How do you get your arms around it?

BUFFETT:  They were terrible.  I mean, the auditors failed, in my view, bigtime when they let, for example, SIVs, be set up, special investment vehicles, with the big banks.  Citigroup had those by the tens of millions.  And what were they trying to do?  They were trying to get around the leverage restrictions that the banks normally had to follow and they were trying to pile up a little more earnings so they could report better quarterly earnings.  So they stuck all this stuff off balance sheet and talked about liquidity puts and all that sort of thing.  And that should be not only just a yellow light, that's a red light to auditors and should have been highlighted but it wasn't.

BECKY:  But what in the current financial regulatory reform can prevent any of those things?

BUFFETT:  Well, I haven't read 1500 and some pages.  But I have the feeling from what I've read about it that Congress is going in the right direction.  I do think -- I think that people that have the ability to attract money with an FDIC guarantee, so they feel it's a government guarantee, if you have the right to do that, there better be some pretty tough rules on what you can do once you gather that money from the public.  Because you are getting it because you have a government guarantee.

BECKY:  Senator Bond, you are one of the 100 people who will be voting on that financial regulatory reform.  Do you think that the bill is the proper bill and that it will be able to prevent some of these extreme situations in the future. 

SENATOR KIT BOND:  Not yet, Becky.  But, Mr. Buffett, I agree with you, we saw a situation where they all get better looking at closing time in the housing market, but the housing market was a team effort.  The administrations, both Republican and Democrat and Congress, pushed for no down payment home loans, nonrecourse loans.  That was an invitation for disaster.  There were a few of us who fought against it unsuccessfully.  But there are certain bad practices that really should be stopped.

And I think you're totally right.  There needs to be regulation of liquidity.  There needs to be regulation of some of these devices.  And, you know, the computer game derivatives that are not based in reality I think deserve to be covered.  But I know you have spoken out about the end users who are in the Heartland, where you and I live, who have to hedge their risk, whether they're farmers, manufacturers, transportation companies.  How should we distinguish between the legitimate hedging activities in financial institutions and the gambling derivatives which you have decried in the past as weapons of mass destruction.

BUFFETT:  In distinguishing, it's really tough.  But it's a job that has to be done because you talk about end users.  I read an article in Business Week a couple of weeks ago about Anheuser-Busch in your state of Missouri.  They use them for hedging purposes.  We're on the Burlington Northern Santa Fe right now.  We use them for hedging purposes with diesel fuel.  And to the extent that people like Anheuser-Busch or Burlington Northern, for example, have to put up a lot of collateral, that is money that is not being used in their own business.  I mean, it's being deposited back in Wall Street.  So I think it is very important to have something that makes sure that end users aren't put in the same category as casino operators.

SENATOR BOND:  Well, I know you have utility.  And I talked to a regional utility in my state that has $100 million in derivatives every day to hedge the cost over the energy input.  And if they had to clear it, it would cost them a billion dollars. 

[CROSS TALK]

BUFFETT:  And sure, Senator.  If they put the money up there, that money is not being used to build wind farms.  And so there are hundreds of end users that have signed on to an appeal to make sure they aren't put in the same category as people who are just basically gambling on them, you have a way that you have got bear traps out there, but they don't catch rabbits.

SENATOR BOND:  Sheila Bair just said that you shouldn't have -- you can't take derivatives out of FDIC-insured institutions without increasing their risk.

BECKY:  Yes, Sheila Bair, over the weekend, I don't know if you have seen these comments yet, is saying exactly that.  She does not want to see the banks not allowed to do derivatives because it will only drive the derivatives and risky business to other institutions that are less regulated.  Do you agree with that or should the banks be limited in what they can do with derivatives?

BUFFETT:  I don't really know the answer to that.  I mean, certainly, banks can use derivatives in ways that makes sense for the society, just in terms of floating rate to fixed-rate loans.  There are various ways of doing it that have a very proper business purpose.  But I think if they are betting on the price at some variable 20 years from now -- when I took over GenRe, there was one derivator contract that lasted 100 years, and that meant for 100 years, no money changed hands, people put marks on it every three months and the trader got paid based on it and people got to report earnings based on it, and so it's hard for me to see that that is serving a wonderful social purpose.

BECKY:  Charlie Munger has a much tougher view on derivatives.  We heard from him earlier.  He says that they should only be allowed on things like energies, commodities and currencies, I believe, or maybe metals.  How do you pair up what you think with what he thinks?

BUFFETT:  Well, Charlie is a little more Old Testament than I am.  I've got a lot of Old Testament in me, too.  But Charlie is right and I'm usually wrong.  But I think that there can be proper uses of beyond the areas he named, but I would agree with Charlie that -- well, the S&P 500 contract is the ultimate derivative.  I mean, it's a bet on an index and it trades by the billions of dollars on tiny margins and it isn't dealing with professional investors all the time.  It's dealing with people that don't know a thing about stocks and bonds and are betting on whether the market is going to be higher 10 minutes later, an hour later.  And it's really hard to imagine what the useful purpose is of dragging in people on tiny margins to gamble on what the stock market is going to do that day.

BECKY:  We have much more to get with with Warren Buffett.  We're going to talk more about the economy because Mr. Buffett, through his businesses, has seen a turn coming in the economy.  We'll get the specifics on that and his read on the strength of the American consumer.  "Squawk Box" will be right back.