Excerpts from Warren Buffett's Annual Letter

(Jason Reed/Reuters)

(Jason Reed/Reuters)

Revered investor Warren Buffett released his annual letter to Berkshire Hathaway Inc. shareholders Saturday morning. Buffett recounted a painful year for his Omaha-based company and the U.S. economy, but the billionaire also offered a hopeful view of the nation's future. The full letter is available online at www.berkshirehathaway.com.

Here's a sample of what Buffett had to say on a variety of topics:

THE ECONOMY
Buffett wrote he's certain "the economy will be in shambles throughout 2009 - and, for that matter, probably well beyond - but that conclusion does not tell us whether the stock market will rise or fall."

Buffett included a chart showing that 2008 was the worst year for a key metric for Berkshire and the performance of the S&P 500 stock index. Berkshire's book value - assets minus liabilities - declined 9.6 percent, and the S&P 500 fell 37 percent last year.

"The period was devastating as well for corporate and municipal bonds, real estate and commodities," Buffett wrote. "By yearend, investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game.

"As the year progressed, a series of life-threatening problems within many of the world's great financial institutions was unveiled. This led to a dysfunctional credit market that in important respects soon turned nonfunctional.

"The watchword throughout the country became the creed I saw on
restaurant walls when I was young: 'In God we trust; all others pay cash."'

THE FUTURE
"Amid this bad news, however, never forget that our country has faced far worse travails in the past. In the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 21.5 percent prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15 percent and 25 percent for many years. America has had no shortage of challenges.

"Without fail, however, we've overcome them. In the face of those obstacles - and many others - the real standard of living for Americans improved nearly sevenfold during the 1900s, while the Dow Jones Industrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during which humans secured only tiny gains, if any, in how they lived.

"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. America's best days lie ahead."

GOVERNMENT BAILOUTS
"In poker terms, the Treasury and the Fed have gone 'all in.' Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel.

"These once-unthinkable dosages will almost certainly bring on
unwelcome aftereffects. Their precise nature is anyone's guess, though one likely consequence is an onslaught of inflation.

"Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won't leave willingly.

"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. 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."

HOME BUYING:
"Home ownership is a wonderful thing. My family and I have enjoyed my present home for 50 years, with more to come. But enjoyment and utility should be the primary motives for purchase, not profit or refi possibilities. And the home purchased ought to fit the income of the purchaser.

"The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability in the future. Home purchases should involve an honest-to-God down payment of at least 10 percent and monthly payments that can be comfortably handled by the borrower's income. That income should be carefully verified.

"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."

INVESTING MODELS:
"The stupefying losses in mortgage-related securities came in large part because of flawed, history-based models used by salesmen, rating agencies and investors. These parties looked at loss experience over periods when home prices rose only moderately and speculation in houses was negligible.

"They then made this experience a yardstick for evaluating future losses. They blissfully ignored the fact that house prices had recently skyrocketed, loan practices had deteriorated and many buyers had opted for houses they couldn't afford. In short, universe 'past' and universe 'current' had very different characteristics. But lenders, government and media largely failed to recognize this all-important fact.

"Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas."

(Copyright 2009 by The Associated Press. All Rights Reserved.)


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