On Friday, the Financial Crisis Inquiry Committee released several hours of audio from a May 2010 interview with Berkshire Hathaway (NYSE: BRK-B) boss Warren Buffett. Below are several of Buffett's comments, lightly edited and condensed for clarity.

On the origins of the bubble: An original sound premise becomes distorted as time passes and people forget the original sound premise and start focusing solely on price action. So everyone -- the media, investors, mortgage bankers, the American public, me, my neighbor, rating agencies, Congress, you name it -- people overwhelmingly came to believe that house prices could not fall significantly. And since it was the biggest asset class in the country and the easiest asset class to borrow against, it created probably the biggest bubble in our history. It will be remembered along with the South Sea bubble and the tulip bubble.

Asked when he saw the crisis coming: Not soon enough. It was something we talked about at our annual meetings. At one point I referred to it as a bubblette -- I don't remember what year that was. I talked about my home in Laguna Beach, where the implicit value of the land got up to $30 million per acre. But I was aware of the Internet bubble too, and I didn't go out and short the stocks. I never shorted Internet stocks, and I didn't short housing stocks. But if I had seen what was coming, I would have behaved differently -- including selling Moody's (NYSE: MCO). So I was wrong.

Asked whether rating agencies contributed to the crisis: Yes. But every aspect of society contributed to it, virtually. They fell prey to the same delusion that existed throughout the whole country. The models they had were no good. They didn't contemplate. But neither did the models and the minds of 300 million Americans.

On the insanity of the financial crisis: I sold a Treasury bill in December 2008 for $5,000,090, and it was a $5 million bill due in April. The guy was going to get $5 million for it. So he was saying that the Treasury bill was $90 better than his mattress. He could have put the $5 million under his mattress and been $90 better off.

Asked why Berkshire sold its Fannie and Freddie investments in 2000: I didn't know that they were not going to be good investments. But I was concerned about management at both Freddie Mac and Fannie Mae. They were trying, and proclaimed that they could, increase earnings per share at some low double-digit range. And any time a large financial institution starts promising regular earnings increases, you're going to have trouble. If people are thinking that way, they are going to do things -- in accounting but also in operations -- that I would regard as unsound. So I just decided to get out.

On Berkshire's 2008 investments in Goldman Sachs and GE: In my own mind, there was only one way the financial world and the economy were going to come out of this situation. I made the fundamental decision that we had the right people in Bernanke and Paulson and a president that would back them up; that we had a government that would take the action that only the government could. I didn't know what they would do. I didn't know what Congress would do. It really didn't make much difference. The important thing was that the American public would come to believe that our government would do whatever it took. And I felt they would. It would have been suicide not to. And therefore I felt companies like General Electric (NYSE: GE) and Goldman Sachs (NYSE: GS) were going to be fine over time.

On moral hazard of bailouts: I think the moral hazard thing is misunderstood in a big way. There is no moral hazard existing with shareholders of Citigroup (NYSE: C), with Freddie Mac, with Fannie Mae, with WaMu, with Wachovia. Those people lost anywhere from 90% to 100% of their money. The idea that they will walk away and think, "Ah, I've been saved by the federal government!" [is wrong]. There's at least half a trillion dollars of loss to common shareholders. Now, there's another question of management. But in terms of moral hazard, I don't even understand why people talk about that in terms of equity holders.

On Wall Street pay: The nature of Wall Street is that, overall, it makes a lot of money relative to the number of people involved and the IQ of the people involved. They work hard. They're bright. But they don't work that much harder and aren't much brighter than someone building a dam and a whole lot of other talents. But in a market system it pays off very, very big. Boxing pays off very big now compared to what it did when the only auditorium you had was 25,000 seats at Madison Square Garden, and now you've got cable television. You can put a couple of lightweights you'll never hear of again on pay-per-view and they'll get millions for it. Market systems produce strange results. Wall Street markets are so big, there's so much money, that taking a small percentage results in a huge amount of money per capita in terms of the people that work in it. And they're not inclined to give it up.

On leverage: If you don't have leverage you don't get into trouble. It's the only way a smart person can go broke. I always say: If you're smart you don't need it, and if you're dumb you shouldn't be using it.

On due diligence: Models work 98% of the time, but they never work 100% of the time. Everyone ought to realize that who uses them.

On investing vs. speculation vs. gambling. It's a tricky definition. It's a lot like pornography and that famous quote. I look at it in terms of the intent of the person engaging in the transaction. An investment operation in my view is one where you look to the asset itself to determine your decision to lay out some money now to get back some more money later on. You don't really care whether there's a quote on it at all.

Speculation I would define as much more focused on the price action of the stock you buy. You are not looking to the asset itself. The real test of what you're doing is whether you care whether markets are open. When I buy a stock, I don't care whether they close the stock market tomorrow for a couple years. I'm looking to the business, Coca-Cola (NYSE: KO) or whatever, to produce returns for me in the future from the business.

Gambling I would define as engaging in a transaction which doesn't need to be part of the system. If I want to bet on a football game, the football game's operation is not dependant on whether I bet or not.

On bank management's contribution to the crisis: They didn't appreciate how extraordinary a bubble could be created. People have a difficult time doing that when a crowd is rushing in one direction knowing the other direction is very hard. Usually the people that do that become discredited by the price action. If you were a Cassandra in 2005 or 2006 and houses kept going up, after a while people quit listening. And a lot of people would just tell you you're nuts -- there's a fringe element to Cassandras. Greenspan had his comments in 1996 about irrational exuberance -- that didn't stop the stock market. When people think there's easy money available they are not inclined to change.

On regulators' contribution to the crisis: The biggest failure is they were unable to act contrary to the way humans act. Regulators could have stopped it. Or Congress could have stopped it. If Freddie and Fannie had said, "We will only accept mortgages with 30% down payments, verified income, and payments can't be more than 30% of your income," that would have stopped it. But who could do that?

Whether Congress would have tolerated them coming up with much stricter standards, I don't think it could have happened. I'm not sure they wanted it to happen either. They were enjoying the party too. And they didn't think the party was going to end like this. It wasn't like somebody was thinking this is going to end in the paralysis of the American economy. They started believing what other people believed. It's very tough to fight that.

I don't think even the president of the United States could have stopped it by rhetoric. If any president campaigned on a program of 30% downpayments and verified income, they might not get impeached but they sure as hell wouldn't get reelected.

On the government's role in housing: I do not see anything wrong with a government guarantee program that kicks in when people really have a 20% down payment. People are still going to lose their homes for unemployment reasons and death and divorce and disability. But that's not going to cause a systemic problem. More people are going to benefit from that program, by far, than anyone that's going to be hurt by it. The government has a place in that.

On free markets: I don't believe the market polices itself. Greenspan is a friend of mine, but he read more Ayn Rand than I did, let's put it that way. I do not believe markets police themselves in matters of leverage and other matters. That's why I get back to the incentives of the person. That makes a difference.

On too big to fail: We'll still have institutions too big to fail. We still have them now -- like Freddie and Fannie. But they aren't too big to wipe out the shareholders. Society has done the right thing with Freddie and Fannie in my view. Nobody has any illusion that the government is protecting them as an equity holder. They do have the belief that they will be protected as debt holders, but we were sending that message well before the bubble.

Institutions that are too big to fail are not too big to wipe out. I think there should be different incentives with institutions like that for the top management. They're not too big to send away the CEOs that caused the problem away without a dime.

On executive compensation: You will have fewer failures if the person on top, and the board of directors who select that person and sets the terms of his or her employment, have a lot to lose. Shareholders have lost well over half a trillion. They've suffered the losses; Society has suffered the losses from all the disruption that's taken place. But directors and CEOs, they may only have 80% of what they had before, but they're all wealthy beyond the dream of most Americans. The people that are in a position to make decisions day by day as to trading off the safety of the institutions versus the chance for improving quarterly earnings, they need different incentives. And so far nothing's been done on that.

On CEO pay packages: The SEC has required more disclosure of pay packages. So you've got this envy factor. You have this ratcheting effect. The more information that's been published about compensation, the worse it's gotten in terms of what people do. They look at the other guy and he's got personal use of the plane or whatever, and that gets built into the next contract. It's changed over the years. And the downside has not paralleled the upside in innovation.

On structuring bank CEO pay to prevent financial crises: The best thing is to have an arrangement in place that, if he ever has to go to the federal government for help, the CEO and his spouse come away with nothing. I think that can be done. If society is required to step in and disrupt the lives of millions of Americans, there ought to be a lot of downside. And that would change behavior more than trying to write some terribly complicated [rule]. This would get their attention. I wouldn't know how to get more specific than that.

[Note: When Buffett says "come away with nothing," he means the CEO and his or her spouse would forfeit their entire personal net worth -- not just that year's compensation.]

On derivatives: You remember the situation with Procter & Gamble (NYSE: PG). If you read the nature of those contracts, they had these exploding factors when you got beyond a certain point. The CFO of a place like Procter & Gamble was probably not understanding those things very well. There's just more money in contracts that people don't understand. So you get this proliferation of these things. And who knows what's in the mind of the end user that thinks they're protecting themselves against this or that -- think Jefferson County, Alabama. It's an instrument that is prone to lots of mischief.

On circle of competence: Anybody that's investing in something opaque should just walk away. Whether it's a common stock or a new invention or whatever. That's why Ben Graham wrote books -- to try to get people to investigate an investment. It's very tough to get that message across sometimes.

On banks' capital vs. liquidity: No capital requirement protects you against a run. If your liabilities all are payable that day, you can't run a financial institution. And that's why we've got the Fed and the FDIC. You can be the most soundly capitalized firm in town. With no Fed or FDIC, if you have a bank capitalized with 10% of capital and I have a bank with 5% capital, and I hire 50 people to stand in front of your bank, you're the guy that's going to fail first. You need the Federal Reserve and the FDIC. I think the FDIC and Social Security were the two most important things that came out of the 1930s. The system needs them.

You can listen to the entire interview here. Comments? Share 'em below.

Fool contributor Morgan Housel owns shares of Berkshire and Procter & Gamble. Berkshire Hathaway, Coca-Cola, and Moody's are Motley Fool Inside Value choices. Berkshire Hathaway and Moody's are Motley Fool Stock Advisor recommendations. Coca-Cola and Procter & Gamble are Motley Fool Income Investor selections. Motley Fool Options has recommended writing puts on Moody's. The Fool owns shares of Berkshire Hathaway, and Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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