By Erik Holm and Andrew Frye
March 2 (Bloomberg) -- Billionaire Warren Buffett said the economy will be “in shambles” this year, and perhaps longer, before recovering from the reckless lending that caused the worst “freefall” he ever saw in the financial system.
The economy and stocks will rebound, and the best days for the U.S. are ahead, said Buffett, chairman of Berkshire Hathaway Inc., in his annual letter to shareholders Feb. 28. Buffett said he’ll spend the recession shopping for new investments for Omaha, Nebraska-based Berkshire.
“The economy will be in shambles throughout 2009 -- and, for that matter, probably well beyond,” said Buffett. “Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so.”
Buffett, an informal adviser to President Barack Obama, said the consequences of the U.S. housing bubble are now “reverberating through every corner of our economy.” Gross domestic product shrank at a 6.2 percent annual pace from October through December, the most since 1982, the Commerce Department said last week.
Late last year, “the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country,” said Buffett, 78. “Fear led to business contraction, and that in turn led to even greater fear.”
Berkshire’s fourth-quarter net income fell 96 percent to $117 million, the firm said Feb. 28. Book value per share, a measure of assets minus liabilities, slipped 9.6 percent for all of 2008, the worst performance under Buffett’s watch, on the declining value of derivatives and the stock portfolio.
‘Socks or Stocks’
Berkshire fell $2,850, or 3.6 percent, to $75,750 at 4:15 p.m. in New York Stock Exchange composite trading. The stock has plunged 46 percent in the past 12 months.
The Standard & Poor’s 500 Index will probably gain in three- fourths of the next 44 years, just as it did in the period since Buffett took over Berkshire in 1965, he wrote. The benchmark dropped 38 percent last year, the most since 1937.
“We enjoy such price declines if we have funds available to increase our positions,” Buffett wrote. “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” Berkshire’s cash hoard was about $25.5 billion at year-end, down from $33.4 billion on Sept. 30.
Buffett disclosed increased holdings of Posco, Asia’s third- largest steelmaker, andSanofi-Aventis SA, France’s biggest drugmaker. Berkshire sold $4.77 billion of equities in the fourth quarter to help fund private deals for preferred shares inGoldman Sachs Group Inc. and General Electric Co. The sales included shares of Johnson & Johnson, Procter & Gamble Co. and ConocoPhillips, holdings that, Buffett wrote, “I would have preferred to keep.”
‘Major Mistake’
Buffett said he made a “major mistake” in buying shares of oil producerConocoPhillips when oil and gas prices were near their peak last year. Berkshire paid $7.01 billion for its remaining stake, which was valued at $4.4 billion as of Dec. 31.
Among his other errors for the year, Buffett listed the purchase of shares in two Irish banks that he didn’t name for $244 million. Berkshire wrote down the stake by 89 percent.
Buffett’s analysis and wit earn attention from professional money-managers and individual investors alike because of his success as a stock picker and businessman. Named the richest American by Forbes magazine in October, he transformed Berkshire from a failing textile maker into a $120 billion company with businessesranging from ice cream to power plants.
Insurance, Utilities
Berkshire’s profit was hurt by writedowns on derivative bets tied to four of the world’s stock markets, while the insurance and utilities businesses fared well because their prospects aren’t correlated with the economy, Buffett said. Liabilities on the derivatives widened 49 percent to $10 billion in the fourth quarter, though the contracts don’t require Berkshire to pay out until at least 2019, if at all.
Buffett decried the way financial companies allowed their derivatives to make them too dependent on each other, and said Berkshire’s contracts are different -- in part, because his firm usually isn’t required to post collateral when assets drop.
For others, “a frightening web of mutual dependence develops among huge financial institutions,” he wrote. “Participants seeking to dodge troubles face the same problem as someone seeking to avoid venereal diseases: It’s not just whom you sleep with, but also whom they are sleeping with.”
Firms with too many derivatives can “infect the entire neighborhood,” he said, and require government help to avoid a wider collapse.
Strong Action
Buffett endorsed efforts by the U.S. to prevent the failure of financial firms including Bear Stearns Cos., which was sold to JPMorgan Chase & Co. The U.S. is being called to commit more capital to ailing companies after the $250 billion in aid it originally allocated last year failed to staunch losses on soured loans at regional lenders and the biggest banks.
“Whatever the downsides may be, strong and immediate action by government was essential last year if the financial system was to avoid a total breakdown,” Buffett said. “Had that occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America were all in the same boat.”
Buffett predicted bailouts will cause “unwelcome aftereffects” including inflation.
“Major industries have become dependent on federal assistance, and they will be followed by cities and states bearing mind-boggling requests,” he said. “Weaning these entities from the public teat will be a political challenge. They won’t leave willingly.”
To contact the reporters on this story: Erik Holm in New York ateholm2@bloomberg.net; Andrew Frye in New York at afrye@bloomberg.net.
Last Updated: March 2, 2009 17:02 EST
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