Berkshire Hathaway Reports Worst Year Ever

loss drivers --Equity and CDS derivatives - 6.8 bil loss --some poor investments such as ConocoPhillips . It is investment gains/loss decreased from 5.6 bil in 2007 to -0.6 bil in 2008. By SCOTT PATTERSON The man considered by many to be the greatest investor of all time just had his worst year ever. Berkshire Hathaway Inc., the large holding company steered by Warren Buffett, reported Saturday that its far-flung empire, ranging from insurance to ice cream to underwear, took some big hits from the sharp economic downturn in 2008. (Berkshire's annual letter to shareholders.) A common metric Berkshire uses to track performance, book value per share, fell 9.6% in 2008, its biggest decline since Mr. Buffett took over the company in 1965 when it was a family-run East Coast textile maker. Berkshire's report was yet another stark sign of the severity of the financial crisis that continues to roil stock markets and businesses around the world. It was only the second year in more than 40 years that Berkshire's book value per share fell; it was down 6.2% in 2001. The company also reported its fifth year-over-year quarterly decline. The $117 million quarterly gain it eked out in the fourth quarter marked a 96% drop from last year's $2.9 billion in fourth-quarter income. Berkshire remains on solid footing with a large war chest of cash and diversified investments, in companies such as Wal-Mart Stores Inc., that are likely to weather the economic upheaval. What's more, the company's book-value performance in 2008 still far outpaced the Standard & Poor's 500-stock index, which fell 37% last year, including dividends, as well as hedge funds, which last year averaged about an 18% decline, according to Hedge Fund Research. Berkshire's results "could have been a lot worse," given the extreme economic conditions, said Morningstar's analyst on the company, Bill Bergman. "It's the worst economic environment in recent history, and despite that they've performed well." Annual Letter Econ: Warren Buffett on the EconomyLetter Highlights: 'Did Some Dumb Things'Berkshire's annual letter to shareholders.More Buffett Takes the Long View; Will Investors? 2/27/09Buffett to Invest in Swiss Re 2/06/09Buffett Helps Harley Refuel 2/04/09Berkshire Net Income Falls 77% 11/08/08Mr. Buffett, in his annual letter closely read by shareholders and nonshareholders alike, said he didn't expect an improved economy any time 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." In 2008, Berkshire's Class A stock fell 32%. This year the shares are down about 19%, slightly better than the Dow Jones Industrial Average. Mr. Buffett credited the federal 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. On oil, he said "odds are good that oil sells far higher in the future than the current $40 to $50 price. But so far I have been dead wrong." And on Treasurys, he contended that the "investment world has gone from underpricing risk to overpricing it." 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." Some highlights of the report: Investments Berkshire's annual net income fell to $4.99 billion in 2008 from $13.21 billion the previous year amid poor results from the firm's insurance holdings and big declines in stock holdings such as Coca-Cola Co. and American Express Co. Berkshire also owns See's Candy, Fruit of the Loom and Benjamin Moore paint, which are privately held, but its insurance businesses generate the bulk of the parent company's results. Mr. Buffett conceded in his letter that he "did some dumb things" in the past year, such as boosting the company's holdings of the oil giant ConocoPhillips when oil prices were near their peak. Since then, oil prices have tumbled and shares of ConocoPhillips and many other energy outfits are down sharply. He also said he made a $244 million investment in two Irish banks "that appeared cheap." At year-end, Berkshire wrote the holdings down to their market value of $27 million, an 89% loss on the investment. The letter also provided new details on some moves Mr. Buffett made in late 2008 as the credit crisis worsened. Berkshire invested $14.5 billion in fixed-income securities from companies such as General Electric Co. and Goldman Sachs Group Inc. To fund the purchases, the letter says, he sold part of his holdings in ConocoPhillips, Johnson & Johnson and Procter & Gamble Co.--"holdings I would have preferred to keep," he said. Derivatives Also cutting into Berkshire's bottom line: A loss of $5.1 billion incurred when several derivatives deals Berkshire entered into in recent years are marked to current market prices. Berkshire sold what are essentially insurance policies against long-term declines in U.S. and foreign stocks in exchange for $4.9 billion. Mr. Buffett said the company sold contracts on the S&P 500, the FTSE 100 in the U.K., the Dow Jones Euro Stoxx 50 index in Europe and the Nikkei 225 Stock Average in Japan. When the contracts 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. Berkshire's liabilities on the contracts have soared as global markets tumbled in the fourth quarter. At year-end, Berkshire's liabilities -- a mathematical estimate of its exposure to its counterparties on the deals -- stood at $10 billion, up from $6.7 billion at the end of the third quarter. That figure was in line with some analysts' expectations. Continuing weakness in global markets in 2009 has dinged the contracts further, Mr. Buffett said. Shareholders' equity, a measure of the company's assets minus its liabilities, declined by an additional $8 billion so far this year, according to the company's estimates, because of weakness in its stock holdings and increased liabilities from the derivatives contracts. At the end of 2008, shareholders' equity stood at $109.3 billion. Mr. Buffett said a small percentage of Berkshire's derivatives contracts call for posting collateral if the market moves against the company. (Meeting costly collateral calls was one of the issues that felled American International Group Inc., the insurer bailed out last year by the federal government.) Berkshire holds 251 derivatives contracts and expanded some of its positions last year, Mr. Buffett said, but most are of the type that don't expose the company to counterparty risk, he said. (This figure doesn't include those derivatives used for operational purposes at its utility outfit, MidAmerican Energy Holdings, and the few remaining at its reinsurance unit General Re.) More broadly, he railed on derivatives as generally too complex and creating dangerous mutual dependence among financial institutions involved. "Auditors can't audit these contracts, and regulators can't regulate them," Mr. Buffett said. He cited Fannie Mae, Freddie Mac and Bear Stearns -- all of which suffered losses because of derivatives and last year either were sold or brought into government control -- as examples of what can go wrong. He faulted the Office of Federal Housing Enterprise Oversight, or OFHEO, which had oversight of mortgage giants Fannie and Freddie. The firms' regulators didn't respond to requests for comment. Insurance Berkshire's powerful insurance business also struggled in 2008 along with the sector. Underwriting profits at Geico, its car-insurance unit, fell 18%, although Mr. Buffett said market share rose to 7.7% from 7.2%. Earnings at General Re slid 38%. Broadly, operating earnings in Berkshire's insurance-underwriting units fell 17% from a year ago to $2.79 billion, hurt by last year's heavy hurricane season. Hurricanes Gustav and Ike inflicted losses on Berkshire's property- and casualty-reinsurance operations of about $900 million, Mr. Buffett said. Reinsurance firms provide financial backstops to other insurance companies. Mr. Buffett also commented on the municipal-bond insurance business he entered in early 2008. He created Berkshire Hathaway Assurance Co. as other, monoline, bond insurers such as Ambac Financial Group Inc. and MBIA Inc. struggled with huge losses amid the credit crisis. Mr. Buffett seemed pleased with some of the deals the company has struck. It has written $15.6 billion of insurance, about 77% of it on bonds that were already insured, making Mr. Buffett's insurer the second, third or fourth to pay, at rates averaging 3.3%. Before he did those deals, he said, he had offered to take over guarantees on $822 billion of bonds insured by the monolines for a lower rate -- 1.5%. They turned him down, he says, which ended up working out in Berkshire's favor because it later scored the better rates -- often for the preferable position of not being first in line to pay. Still, Mr. Buffett sounded a warning for the municipal-bond insurance business: the risk that local governments running short of cash may decide to default on bond payments if they carry bond insurance. Shortfalls in many city and state pension funds at the end of the year were "staggering," he wrote, and could push some local governments to inflict pain on bond insurers. "What mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a far-away bond insurer?" Mr. Buffett said. —Lavonne Kuykendall contributed to this article. Write to Scott Patterson at scott.patterson@wsj.com