WALL STREET JOURNAL: For Buffett, It Was a Very Bad Year

By SCOTT PATTERSON

March 2 2009

The man considered by many to be the greatest investor of all time just had his worst year ever.

But the results released Saturday for Warren Buffett"s company, Berkshire Hathaway Inc., also demonstrate how recently, and over time, the investor has positioned his far-flung empire to weather the financial storm.

Associated Press

Warren Buffett

Mr. Buffett, in his annual letter, read closely by shareholders and nonshareholders alike, reported Berkshire in 2008 lost 9.6% in book value per share, a common metric Berkshire uses to track performance. That marks the biggest decline since Mr. Buffett took over in 1965, when it was a family-run East Coast textile maker.

Mr. Buffett conceded he "did some dumb things." Among them: scooping up shares of oil giant ConocoPhillips when oil prices were near a high and investing $244 million in a pair of Irish banks that hit trouble, resulting in an 89% loss.

Berkshire shares fell nearly as much as the rest of the market last year, indicating that investors are worried about the company"s ability to keep growing. In 2008, Berkshire"s Class A stock fell 32%. This year, the shares are down nearly 19%, slightly better than the Dow Jones Industrial Average.

Yet many analysts were pleased that the decline in book value per share wasn"t steeper. And Mr. Buffett"s results also show he has made moves that have paid off and should continue to do so even if economic woes persist, as he predicts.

He limited his exposure to complex and potentially costly derivatives in his reinsurance unit, General Re Corp. He has $24.3 billion in cash that can be used to find bargains in a distressed market. And he"s made several investments in preferred stock of firms such as Goldman Sachs Group Inc. that pay out steady income of 10% or more.

"He"s done a great job to prepare for this," said Paul Howard, an analyst at Langen McAlenney, a Hartford, Conn., research group, who rates Berkshire a "buy." "He"s got good businesses that are generating a lot of cash, and he"s going to continue to put that money to work."

Berkshire"s substantial insurance holdings haven"t needed to take the massive write-downs on toxic subprime securities that have plagued much of the financial industry in the past two years. One reason is Mr. Buffett"s longstanding dislike of complex derivatives, which he famously called "financial weapons of mass destruction" in his 2002 shareholder letter and which he railed on again in his latest letter. He pushed General Re, the large reinsurance company Berkshire acquired in 1998, to disentangle itself from a vast web of derivatives -- financial instruments tied to the value of other securities, such as stocks or bonds -- over the course of five years, winding down its book of 23,218 derivatives contracts at a loss of about $400 million, he said in the letter. The losses may have been far more substantial if General Re had held onto to the contracts, Mr. Howard said.

"Upon leaving, our feelings about the business mirrored a line in a country song: "I liked you better before I got to know you so well,"" Mr. Buffett wrote, referring to General Re"s derivatives book.

Separately, Berkshire took a loss of $5.1 billion in the fourth quarter on several derivatives contracts entered into in recent years. The contracts, essentially insurance policies against long-term declines in U.S. and foreign stocks, expire in 15 or 20 years. Berkshire will have to pay out if the indexes are below where they stood when the deals were struck. The derivatives, whose current estimated value has to be reflected on Berkshire"s books, are one reason the company reported a grim fourth quarter on Saturday -- its fifth year-over-year quarterly decline.

The $117 million quarterly gain it eked out in the quarter marked a 96% drop from last year"s $2.95 billion in fourth-quarter net income.

Beyond commenting on Berkshire, Mr. Buffett shared his views on the broader economy and financial systems. He doesn"t expect the economy to improve soon but did expect better times, eventually.

"Our country has faced far worse travails in the past," he said. "Without fail, however, we"ve overcome them." He declined to draw a correlation between stocks and economics, saying that while he was certain the economy would be "in shambles for 2009," that "does not tell us whether the stock market will rise or fall." He credited the government for stepping in with massive assistance last year, saying the intervention was "essential" to avoiding a total breakdown. But he cautioned there could be "unwelcome aftereffects," such as inflation.

He contended the "investment world has gone from underpricing risk to overpricing it," which he said is reflected by investor appetite for Treasury bonds. Future historians will comment on the Internet bubble of the 1990s and the housing bubble of the early 2000s, he said, but "the U.S. Treasury-bond bubble of late 2008 may be regarded as almost equally extraordinary."

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