ALL BUSINESS: Buffett says economic and credit woes linger

Buffett's assessment is a much-needed wake-up call to investors who have been pushing stock prices higher and are warming up to owning risky debt again, both big bets that the worst of the credit crisis is over and better times are ahead.

Feeding that shift in sentiment has been better-than-expected economic and financial news, which at first glance does look good. It's when you dig a little deeper that it's more evident why it's not.

Buffett spoke over the weekend during events surrounding the annual meeting in Omaha of his company, Berkshire Hathaway Inc. He said the Federal Reserve's bailout of Bear Stearns in mid-March likely averted a broad financial crisis on Wall Street, which could have spurred a run on other investment banks and crippled the financial system.

The "idea of financial panic" has largely been "fairly well taken care of," he said, but he predicted the pain is far from over for financial institutions. They've already taken more than $200 billion in write-downs on their mortgage-related and other debt assets as their valuations have slumped, and he suggested more bad news could be coming.

Buffett also said that the U.S. economy is in a recession by his definition -when most people and businesses are not doing as well as they were three, six or nine months ago. The commonly used criteria for a recession is two quarters of negative growth.

That contrasts with the upbeat view embraced by investors in recent weeks, who have been taking a glass half-full approach to financial conditions after months of seeing them as only being half empty -or worse.

Just look at the turnaround in the Standard & Poor's 500 stock index: After tumbling more than 13 percent from the start of 2008 through the Bear Stearns mess on March 17, it has gained more than 10 percent since.

Credit investors have also turned more bullish over the last month. The option-adjusted spread on the Merrill Lynch's high-yield corporate bond index -representing the difference in yield between the most speculative corporate debt and risk-free Treasury securities -has narrowed from 840 basis points on March 20, to around 685 basis points last week, according to research firm CreditSights.

Among the data points feeding such gains was the May 1 report from the Commerce Department showing a surprising 0.6 percent growth in gross domestic product during the first quarter. To many investors, it was proof that the economy isn't in a recession and gave then a psychological boost.