Warren Buffett Credit Crisis Primer

Whatever your opinion about the $700 billion bailout bill that became law yesterday, it's useful to know what knowledgeable proponents think about it. Few know as much or can communicate their views as clearly as the charming "Oracle of Omaha," Warren Buffett.

Buffett, of course, is chairman of Berkshire Hathway Inc. and one of the richest men in the world. He predicted the credit crisis in his 2002 annual letter to stockholders (starting at pdf page 12 and print page 13) -- well before most others:

[T]he parties to derivatives also have enormous incentives to cheat in accounting for them. Those who trade derivatives are usually paid (in whole or part) on “earnings” calculated by mark-to-market accounting. But often there is no real market (think about our contract involving twins) and “mark-to-model” is utilized. This substitution can bring on large-scale mischief. As a general rule, contracts involving multiple reference items and distant settlement dates increase the opportunities for counterparties to use fanciful assumptions. In the twins scenario, for example, the two parties to the contract might well use differing models allowing both to show substantial profits for many years. In extreme cases, mark-to-model degenerates into what I would call mark-to-myth.

Four days ago, Buffett spent an hour with PBS' Charlie Rose discussing the then-pending bailout bill. The full video of their lengthy conversation can be seen here. It is engaging but long, in no small part because of Charlie Rose's annoying verbosity.

Happily for you, that nearly one-hour video has been edited down to a little over 17 minutes (see below) that captures the essential dozen major points that Buffett wanted to make.

He favors the bailout bill but has no illusions that it is a panacea. He warns, however, that to work at all well, the Treasury Department must use its new authority not to "bail out" banks but to "invest" in them by paying mark-to-market prices for their toxic mortgage derivative portfolios.

Despite Buffett's sunny disposition and irrepressible optimism about the future of the country, he also warns that what lies ahead even if the bill works are more bank failures, rising unemployment, a falling dollar, severe inflation -- and, even now, the "possibility" of a depression.

Here's a choice for you. To understand what's going on you could choose, if you wish, to search the internet for the invariably insipid remarks of Northwest Florida's feeble congressman Jeff Miller, who voted against the bill; or, you could learn something by listening to the Oracle of Omaha: