Warren Buffett: Crisis is 'Economic Pearl Harbor'

If Mr.Capitalism says it then it must be really bad.

Billionaire investor Warren Buffett called the $700 billion U.S. bailout plan "absolutely necessary" to help pull the financial system out of an "economic Pearl Harbor."

Speaking on CNBC television on Wednesday, the 78-year-old Buffett also called on Congress to leave no doubt by Friday that a bailout would be adopted, or risk throwing markets and the economy into further turmoil.

"We were very, very close to a system that was totally dysfunctional, and would have not only gummed up the financial markets but gummed up the economy in a way that would take us years and years to repair," Buffett said, referring to recent events.

[...]Buffett's insurance and investment company, announced a $5 billion investment in Goldman Tuesday.

"I'm not buying a cross-section of banking institutions," Buffett said. "I certainly have confidence in Goldman, and you could say it's a vote of confidence in Congress to do the right thing."

As lenders try to reduce balance sheet risk, Buffett said the government should buy some of the assets they unload, but not at inflated prices.

"There is no one that can leverage up like the United States government," Buffett said. "If they do it right, and I think they will do it reasonably right ... they'll make a lot of money."

It looks pretty bleak. But the solution lies with listening to people like Buffett. He should be at the White House in those meetings on the government "rescue plan."

One Congressman questioned whether the bailout is necessary, since Mr Buffett's purchase suggested confidence was returning. But Mr Bernanke said: "Mr Buffett said on TV this morning that he thought Congress would act, and if Congress didn't act we would go over a precipice." It seemed increasingly likely yesterday that the Treasury would accept legislation to limit executive pay as a quid pro quo. Democrats were also pushing for the government to take equity stakes in companies that receive assistance, and some suggested the $700bn should only be released in increments.

Financial markets remained on tenterhooks. Investors bought short-term US government bonds as a safe haven, fearing a credit market meltdown if legislation is not passed. In Hong Kong, thousands of savers mobbed the offices of the Bank of East Asia amid text message rumours that it was about to go under. The bank vehemently denied the rumours.

"The market could not have taken another week like what was developing last week," Mr Buffett told CNBC. "Last week will look like Nirvana if they don't do something. I think they will. I understand they're very mad about what's happened in the past, but this isn't the time to vent your spleen about that." He predicted that the taxpayer would make a profit on its investments in toxic mortgage debt. "If I had $700bn on the government's terms to buy distressed assets, I would," he said. "Unfortunately, I'm tapped out."

The value of trillions of dollars of mortgage-related derivatives has collapsed since the housing market turned down, and their ultimate value rests on where house prices settle and how widespread foreclosures become. The latest data on the sale of existing homes, out yesterday, showed 10.7 per cent fewer transactions in August than a year ago, at an average price down 9.5 per cent.

In his testimony to the Joint Economic Committee of Congress yesterday, Mr Bernanke painted his bleakest outlook yet for the US economy, and he warned it would get even worse if the bailout is not successful.

"Ongoing developments in financial markets are directly affecting the broader economy through several channels," he said. "When worried lenders tighten credit, then spending, production and job creation slow. Real economic activity in the second quarter appears to have been surprisingly resilient, but, more recently, economic activity appears to have decelerated broadly." He said that the market turmoil was causing problems overseas that would hold back exports – which has been the most robust plank of economic growth and kept the US out of recession since the credit crisis broke.

Bush is perfectly correct on the root cause of the problem. But he doesn't mention is that his administration's policies accelerated the conditions that led to the bubble bursting.

First, how did our economy reach this point? Well, most economists agree that the problems we're witnessing today developed over a long period of time. For more than a decade, a massive amount of money flowed into the United States from investors abroad because our country is an attractive and secure place to do business.

This large influx of money to U.S. banks and financial institutions, along with low interest rates, made it easier for Americans to get credit. These developments allowed more families to borrow money for cars, and homes, and college tuition, some for the first time. They allowed more entrepreneurs to get loans to start new businesses and create jobs.

Unfortunately, there were also some serious negative consequences, particularly in the housing market. Easy credit, combined with the faulty assumption that home values would continue to rise, led to excesses and bad decisions.

Many mortgage lenders approved loans for borrowers without carefully examining their ability to pay. Many borrowers took out loans larger than they could afford, assuming that they could sell or refinance their homes at a higher price later on.

Optimism about housing values also led to a boom in home construction. Eventually, the number of new houses exceeded the number of people willing to buy them. And with supply exceeding demand, housing prices fell, and this created a problem.

Borrowers with adjustable-rate mortgages, who had been planning to sell or refinance their homes at a higher price, were stuck with homes worth less than expected, along with mortgage payments they could not afford.

As a result, many mortgage-holders began to default. These widespread defaults had effects far beyond the housing market.

See, in today's mortgage industry, home loans are often packaged together and converted into financial products called mortgage-backed securities. These securities were sold to investors around the world.

Many investors assumed these securities were trustworthy and asked few questions about their actual value. Two of the leading purchasers of mortgage-backed securities were Fannie Mae and Freddie Mac.

Because these companies were chartered by Congress, many believed they were guaranteed by the federal government. This allowed them to borrow enormous sums of money, fuel the market for questionable investments, and put our financial system at risk.

The decline in the housing market set off a domino effect across our economy. When home values declined, borrowers defaulted on their mortgages, and investors holding mortgage-backed securities began to incur serious losses.

Before long, these securities became so unreliable that they were not being bought or sold. Investment banks, such as Bear Stearns and Lehman Brothers, found themselves saddled with large amounts of assets they could not sell. They ran out of money needed to meet their immediate obligations, and they faced imminent collapse.

Other banks found themselves in severe financial trouble. These banks began holding on to their money, and lending dried up, and the gears of the American financial system began grinding to a halt.