Buffett backs Goldman Sachs

(Fortune) -- Warren Buffett offered his strongest defense yet of Goldman Sachs, saying he doesn't believe the investment bank acted improperly in a sale of subprime-related securities at the heart of a Securities and Exchange Commission fraud case.

"I do not hold against Goldman at all that an allegation has been made," Buffett said Saturday at Berkshire's annual shareholder meeting in Omaha. He adds that he "loves" Berkshire's lucrative investment in Goldman preferred stock and believes the firm remains the best investment bank in the world.

The fraud case and reports that the Justice Department may pursue a related criminal case have hit Goldman's stock hard. Shares have dropped 22% in the past two weeks and closed Friday at their lowest level since last July.

But Buffett defended the bank and its CEO, Lloyd Blankfein, even as some on Wall Street are wagering the SEC case may lead to Blankfein's departure. Asked who else should run Goldman (GS, Fortune 500) if Blankfein had to step down, Buffett said he has "never given that a thought. There's really no reason."

The SEC stunned Wall Street two weeks ago by filing a civil fraud case alleging that Goldman misled investors in a 2007 sale of subprime-backed debt, by failing to disclose that a hedge fund manager who was betting against the investment helped to select the securities in the transaction.

The hedge fund manager, John Paulson, made $1 billion when the investment lost all its value within months. That caused major losses at two big European banks.

The SEC said Goldman deceived the investors in the deal, known as Abacus 2007-AC1, by failing to disclose the inherent conflict posed by Paulson's bet against the portfolio.

Goldman has said it acted properly, and Buffett said he believes ACA, a bond insurer that made a $900 million bet on Abacus that was backed by Dutch bank ABN Amro, failed to weigh the risks involved.

"They made what turned out to be a dumb insurance decision," Buffett said. "I don't see what difference it made who was on the other side of the deal."

Buffett made his comments in response to shareholder questions at the Berkshire (BRKA, Fortune 500) annual meeting.

One questioner brought up Buffett's 1991 testimony before a House subcommittee on the Salomon Brothers Treasury bond scandal, in which Buffett - who had just taken charge of Salomon as the Treasury actions threatened to bring it down -- famously promised to be "ruthless" when any employee acted in a way that hurt the firm's reputation.

But both Buffett and his longtime investing partner, Berkshire Vice Chairman Charlie Munger, made clear they don't view the allegations against Goldman as rising to the seriousness of that case, in which Salomon was accused of trying to manipulate the market for Treasury securities.

"There's no question that the ... press of the past few weeks hurt the company," Buffett said, adding that "the allegation of something" did not fall in his "category of losing reputation."

Munger noted that he would have voted with the two Republicans on the SEC who opposed bringing a civil fraud charge against Goldman. He and Buffett also agreed they didn't believe Goldman had a duty to disclose to shareholders when it received a so-called Wells notice -- a letter from the SEC indicating charges were likely.

And though Buffett acknowledged the past two weeks have been "painful" for Goldman, he said the allegations are actually positive, in one way, for Berkshire.

The company made a $5 billion preferred stock investment in Goldman in September 2008, at the height of the financial crisis. The shares pay Berkshire $500 million in annual dividends -- or more than $15 a second, Buffett said.

Buffett said he has been expecting Goldman, as is its right, to buy Berkshire out of the costly preferred shares by paying Berkshire $5.5 billion. Berkshire would then likely reinvest those funds in safe securities paying around $20 million annually.

But with investigations swirling around Goldman, regulators aren't likely to soon allow Goldman to repay Berkshire, Buffett said. That means the healthy dividend checks should keep rolling in for a while.

"Every day that Goldman doesn't call our preferred is money in the bank," Buffett said. "That's $15 a tick. Tick, tick, tick. I don't want those ticks to go away."

Buffett also reported Saturday that operating earnings at Berkshire Hathaway (BRKB) rose 30% from a year ago in the first quarter, as economic activity has picked up this spring.

Berkshire posted a first-quarter profit of $3.6 billion. That reverses a year-ago loss of $1.5 billion. As always, the results were heavily affected by gains and losses on the firm's investments and derivatives contacts.

Excluding those noisy factors, as Buffett prefers to, Berkshire's operating profit rose to $2.2 billion in the quarter from $1.7 billion a year earlier.

The gains were driven by strong results at Berkshire's operating businesses, which range from utilities and railroads to metalworking and furniture.

Profit at the company's regulated businesses, including big electric generator MidAmerican Energy and recently acquired railroad Burlington Northern, more than doubled to $555 million.

Earnings at the company's manufacturing, service and retail arms rose sharply as well, jumping 85% to $477 million.

Insurance earnings slipped from a year ago though, to $1.16 billion from $1.2 billion a year earlier. Berkshire owns auto insurance giant Geico among other insurance businesses.

While jobs are returning slowly after a long recession, "business is coming back more than slowly," Buffett told CNNMoney.com. He said March and April were "very strong months" in the company's operating businesses.

"People have regained confidence to some degree," Buffett said. "There has been a real resurgence in demand."