Warren Buffett says the American economy will be “in shambles” for the rest of this year and longer as financial firms take losses tied to reckless loans made during the housing boom.
While Buffett and his business partner Charlie Munger say they can’t predict how stocks will perform in 2009, they’re certain “that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond”.
The comments came in his now famous annual letter to Berkshire shareholders, released at the weekend.
His letter was released after new figures showed the US economy was worst placed than previously thought after gross domestic product shrank at a 6.2% annual rate in the December quarter, the biggest contraction since 1982.
Buffett said the consequences of the US housing bubble are now “reverberating through every corner of our economy”.
“The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability in the future,” he wrote to shareholders.
“Home purchases should involve an honest-to-God down payment of at least 10 per cent and monthly payments that can be comfortably handled by the borrower’s income.
“Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective. Keeping them in their homes should be the ambition.”
Buffett’s letter also accompanied the release of Berkshire’s fourth-quarter and annual results, in which net earnings fell 96% to $US117 million on losses from derivative bets tied to stock market performance from 2019 to 2028.
These contracts are not understood by investors and the market generally, helped by inept comparisons by reporters for quite a few groups.
As a result Berkshire shares have sharply fallen in the past year as the value of the firm’s top stock holdings dropped and losses increased on the derivatives.
But the company’s investments before mark to market adjustments were down 9.6%, 27% better than the 37% fall in the Standard & poor’s 500.
All told the company shed $US11.5 billion of its net worth in 2008 Buffett told investors in a letter.
Berkshire generates about half its results from insurance, including auto insurer Geico Corp, reinsurer General Re and over 70 other businesses that offer such things as jewellery, carpeting, ice cream, paint, real estate services, underwear, high end machine tools and software and power and gas utilities in the US and UK. It also offers pleasure boats; jet leasing and last month bought $US250 million in bonds for Tiffany’s.
Describing market conditions at the end of the year Buffett said "investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game".
It is the worst performance of the group since it was founded in 1965.
Berkshire’s shares have taken a beating. The A stock dropped from $US142,000 at the end of 2007 to $US96,600 a year later, and in 2009 it has fallen further, closing at $US78,600 on Friday.
From its high of $US151, 000 hit in late 2007, the stock is down 48%.
Nevertheless, he wrote that Berkshire owns 251 derivatives he believes were mispriced at their inception, in Berkshire’s favour.
"If we lose money on our derivatives, it will be my fault," Buffett said.
Berkshire has received $US8.1 billion in payments for derivatives which can be invested until the contracts expire years from now.
He hasn’t paid out on the contracts and has been forced to cut their value under the mark-to-market rule because of the drop in the US markets.
Berkshire has to estimate the value of its derivatives every quarter. Buffett says he supports mark-to-market accounting, but says the formula used to estimate that value can produce absurd results for long-term contracts.
He said America – and much of the world – became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear.
By the fourth quarter of last year, “the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country,” Buffett said.
“A freefall in business activity ensued, accelerating at a pace that I have never before witnessed."
Buffett endorsed efforts by the US government to prevent the failure of financial firms including Bear Stearns Cos., which was sold to JPMorgan, almost 12 months ago.
"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."
"Most of the Berkshire businesses whose results are significantly affected by the economy earned below their potential last year, and that will be true in 2009 as well.
"Our retailers were hit particularly hard, as were our operations tied to residential construction.
"In aggregate, however, our manufacturing, service and retail businesses earned substantial sums and most of them – particularly the larger ones – continue to strengthen their competitive positions.
"Moreover, we are fortunate that Berkshire&rs
