The Oracle of Omaha loses his visionary powers – and feels the heat

A defensive performance in front of shareholders shows even Warren Buffett is not immune to the credit crunch

Warren Buffett’s sage investment advice and stellar profits long ago earned him the nickname the Oracle of Omaha, and his prediction that credit derivatives would prove to be “financial weapons of mass destruction”, which came gruesomely true last year, should have sent his reputation into the stratosphere.

And yet the billionaire investor was forced uncharacteristically on to the defensive at his annual shareholder meeting, asked to justify his investments in a credit rating agency at the heart of the financial crisis, a bank that had to take US government bailout money, and in derivatives that are continuing to erode his company’s profits.

Arecord crowd of 35,000 shareholders in Mr Buffett’s Berkshire Hathaway descended on this modest midwestern city over the weekend, but an event that is routinely dubbed the “Woodstock of capitalism” struck some less raucous notes this year.

The reason is that Berkshire’s shares have lost more than a quarter of their value in the past year, its investments have lost 10 per cent of their book value, and the company has lost its coveted AAA credit rating. It was 79-year-old Mr Buffett’s worst performance ever.

The exhibition hall at the Qwest Centre in downtown Omaha was again buzzing with Berkshire’s subsidiary companies hawking their wares. Shareholders guzzled Dairy Queen ice creams and stuffed bags full of See’s Candies chocolates.

There were Fruit of the Loom t-shirts for kids bearing the legend “Future Shareholder”. On stage, Mr Buffett swigged Coca-Cola, one of Berkshire’s longest-held stakes.

These are the products the Oracle never fails to name-drop as he dispenses his folksy advice, using them as examples of the timeless brands he says make lucrative and easilycomprehensible investments.

But the events of the past year have been a reminder that Mr Buffett’s empire is based in very large measure on less easily understood businesses: financial subsidiaries including insurance and reinsurance companies; shareholdings in American Express, theWells Fargo bank and Moody’s; plus a portfolio of his occasional bets – using derivatives – on the future direction of currencies, equity markets or government bonds.

His very first comments at the meeting highlighted a bet he had taken that US Treasury bills would fall between December last year and this April. In December, they were so highly priced that they were yielding nothing, as scared investors were effectively paying to house their money with the US government. “I don’t think we’ll see that again in our lifetimes,” he said.

Derivatives called equity put options – bets that the stock market will go up – are also going against Mr Buffett, dragging down his profits again in the first quarter of the new financial year, but he insisted that “the odds are extremely high” that they will make money over their 15 or 20-year life. Berkshire is also selling credit default swaps, effectively insurance against bond defaults, and Mr Buffett said he expected to lose money on those. A number of shareholders challenged him to explain how Berkshire could have allowed Moody’s, the credit rating agency in which it has a 20 per cent stake, to become so heavily involved in the credit derivatives market, giving a stamp of approval to trillions of dollars of mortgage derivatives that have since turned toxic, trashing the company’s reputation and opening it up to legal action – not to mention the wider fall-out for the world economy, since their gold-plated ratings encouraged a boom in mortgage financing, made mortgages available to poorer Americans and inflated a house price bubble.

Critics have argued that because Moody’s was being paid handsomely by the banks to rate instruments, it has a clear conflict of interest, but Mr Buffett said he didn’t think the payment system contributed to the disaster.

“Five years ago, nearly everyone in the country had made the judgement that house prices could not fall significantly. They made a major mistake, but they made a mistake that a great number of different people made,” he said. “If they had taken a different view, they would have been answering to Congress, which would have been asking why they were being un-American.”

In fact, Mr Buffett had gone out of his way to invite tough questioning this year. As always, Berkshire threw open the microphones to diehards who had been queuing from before dawn to seek his wisdom on topics from the government stimulus package (necessary, but with unpredictable consequences) to what the Chinese government should do with its dollar reserves (get used to the idea that their value will be eroded by US inflation). But he also took questions submitted by email and filtered by a panel of prominent journalists.

During the meeting, shareholders were given a sneak preview of Berkshire’s first-quarter results, which showed another decline in profits and in the book value of its investments.

Operating profits were down 12 per cent and book value by 6 per cent.

And Mr Buffett revealed that a new generation of managers that he is secretly grooming to take his place have also not shone through the financial crisis. He has identified four fund managers who could take over the chief investment officer part of his role at Berkshire (he has other candidates in mind to take over as chief executive), but all managed only to match the S&P 500 index last year – that is, they were down around 37 per cent. “For 2008 by itself, I would not say that they covered themselves with glory, but then I didn’t cover myself with glory either.”

“That was one of the most interesting things we learnt today,” said Brendan Watt, whose father owns Berkshire shares, and who had travelled from Boulder, Colorado, to help decide if he wants to buy shares of his own. “The risks are hard to quantify, since no one knows how the world will react to Mr Buffett’s passing. For now, though, it is interesting to see him screw up. It’s heartening for the rest of us.”