“Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”—Warren Buffett
Back in the early days of this century, Warren Buffett faced a rare—although not as rare as some believe—financial setback and public relations disaster when Berkshire Hathaway was forced to shutter its General Reinsurance securities unit, which it had purchased for $22 billion only a few years earlier. The Berkshire-owned company found itself caught up in the financial and accounting scandals, with its business facing serious losses and its executives under investigation by the SEC and facing numerous criminal prosecutions. Even after the company shut it down, General Re, which was a major derivatives dealer, was stuck with 14,384 outstanding contracts with 672 counterparties outstanding, with billions of dollars on the line. Buffett’s personal fortune fell by $5 billion to $30 billion, reducing him to rank of “second richest person” behind Bill Gates.
Right around that time, Buffett publicly turned against derivatives. “When Charlie [Munger,] and I finish reading the long footnotes detailing the derivatives activities of major banks, the only thing we understand is that we don’t understand how much risk the institution is taking,” he told investors.
But not understanding derivatives and publicly attacking their role in global finance hasn’t stopped Berkshire Hathaway from selling derivative contracts on stock indexes and bonds. This year the company has collected premiums of about $2.5 billion from these derivatives, according to a report in the Wall Street Journal. Buffett once compared being the derivatives business to being in Hell. And, apparently, he likes it there.
Is this rank hypocrisy? Perhaps it depends on what your definition of derivatives is. From the Wall Street Journal article, it’s hard to tell what exactly Berkshire Hathaway has been selling. But it sure sounds like credit derivative swaps. Those derivatives, of course, are part of what fueled investor’s ravenous appetite for corporate debt—at least until the recent credit crunch. It was often said that these derivatives weren’t making the world a riskier place but helping diversify risk—although that assessment in now undergoing a general re-assessment. And these are often considered some of the riskiest types of derivative products on the market.
The lesson seems to be: Watch what they do, not what they say. Especially if they say it in a folksy Midwest way.
Buffett Scores With Derivatives [Wall Street Journal]
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Warren Buffett Admits To Manufacturing Weapons Of Mass Destruction
By Joe WeisenthalComments (16)
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All that matters is who has the better record of success at the end of the day. Scoreboard: Buffett.
The posts today are so rife with errors that they are almost unreadable. I know you guys work hard to get these entries out, but come on, just read it over ONE TIME before you submit it. It just takes away from whatever objective you have (humor or otherwise), and makes you guys look like you are a bunch of high school kids working out of your parents basement.
General Re, which was a major derivatives dealer, was stuck with 14,384 outstanding still stuck with 14,384 contracts outstanding with 672 counterparties
ever proofread what you post?
“with billions of money on the line”
Attn: All you reporter dolts who now work for me must quit editing Dealbreaker on company time and try to come up with some new ideas on your own. It is beginning to show, you know.
NYT has nice piece on Maria B today.
Isn’t it obvious that the answer is no. Actually, we do. But we writes thousands of words a day in between researching and reporting, and errors slip in frequently. We do our best to minimize these but there are no dedicated proof readers. Other than our readers. We report, you edit. Come on people. Learn your place in this thing!
By the way, the “billions of money” was joke that we obviously screwed up by our earlier typo. We just thought that was a funny way to say it.
The article clearly mentions equity derivatives so it’s not just about credit derivatives Why don’t you dig through the notes and piece it together? Too much work?
Buffet is a known hypocrite. Whats new?
He wasn’t just selling credit default swaps, he was selling out of the money puts
WEB said he writes, with the help of a fairly good writer, his annual reports so that his not too financially savvy aunts can understand them. Another one is something along the line that ” all that is needed in this business is high school math”.
Carney:
Jeff Mathews did an excellent post on this a while. This is quite a famous quote of Buffet’s part. The most interesting fact being that Buffet believed that a large portion of the contracts being underwritten by General Re are long dated and hard to value so that the derivatives traders could balance out their P&L by marking to model, whenever they had a down year.
Funnier still Charlie Munger called Salomon’s “legendary arb desk” a stick with shit on both ends. Which is probably a more accurate assessment of some of the more complex derivatives. Not because they are inherently ill suited investments but because their are so few people who can value them that a functional market cannot be formed.
Rick Bookstabber wrote extensively on this in his book a Demon of Our Own Design
Weapons of ass destruction, you mean, considering that he must’ve been banging Liz Claman and more recntly, Becky Quick.
No such thing as hypocrisy in business or war.
I agree with anon anon anon. In private, Buffet is a sophisticated investor who writes derivatives all day long (that’s what insurance really is, after all), and was even willing to buy LTCM. But in public, her persona is Grandma Buffet who invests in nothing but chewing gum factories, based on 5 minute decisions made using 9th grade math.
I meant “HIS persona is …”