Derivatives on deck for Buffett faithful
Warren Buffett claims to love simple things like ice cream. But some 40,000 shareholders at Berkshire Hathaway’s annual powwow in Omaha this weekend may hear a lot about complex derivatives.
For someone who once called these instruments “financial weapons of mass destruction,” the Sage of Omaha has accumulated quite a portfolio. He has written puts on various equity indices and some credit default protection too, with a worst-case exposure of $63 billion. More realistically, the market value of Berkshire’s derivatives liabilities stood at around $9 billion at the end of last year.
But when Berkshire first issued the contracts, it banked premiums nearly as large as those end-2009 liabilities. It is churning out $8 billion in annual free cash flow, according to Barclays Capital. And Berkshire’s equity is measured in multiples of its debt, not the other way around. As Buffett may indicate on Saturday, this makes the derivatives risk look modest — unlike the disastrously oversized exposures built up by highly leveraged financial institutions like American International Group.
Buffett may well also break his recent silence on Goldman Sachs. The billionaire investor sank $5 billion into the investment bank during the financial crisis. But now, a complex derivatives-based deal has led to fraud charges from the Securities and Exchange Commission. Goldman disputes the accusations, but its reputation is taking a battering — and the drop in the company’s share price has so far cost Berkshire about $1 billion.
Between Dairy Queen cones and requests for advice about investments and life in general, shareholders could also be curious about his thoughts on financial regulatory reform proposals in the U.S. Senate. As far as derivatives go, there’s a risk Berkshire is forced to post billions in collateral on existing trades — something they were designed to avoid and which Buffett’s crew has lobbied against. New rules could also crimp Goldman’s activities.
The Berkshire boss may feel new curbs are inevitable. In his most recent annual letter, he said those running financial institutions need to take more responsibility. If Berkshire takes too much risk on derivatives or otherwise, and runs into trouble, he said, “It will be my fault.” Wall Street’s leading lights still tend to argue they never saw the crisis coming.
Buffett may well have pungent views about that too.