Warren Buffett Is Wrong on This One

I'm a Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) shareholder. Have been for years. I've learned a lot reading Warren Buffett's words of wisdom, as most of us have. It's not a stretch to call Buffett the most-decorated financial role model/superhero/guiding light/voice of reason the world has ever seen.

But his latest move let me down, and I'm not afraid to call him out on it.

Reputational arbitrage
Let's step back for a second. A few weeks ago, former International Monetary Fund chief economist Simon Johnson called JPMorgan Chase (NYSE: JPM  ) CEO Jamie Dimon "the most dangerous man in America." Not because his actions have been reckless, but just the opposite. Dimon navigated the financial crisis better than any bank CEO. That unblemished reputation has given him enough political bargaining chips to argue for entrenching the status quo, particularly regarding the issue of too big to fail. And people listen to him. Politicians trust Dimon. President Obama once personally endorsed him.

If Dimon says no regulation is needed, then he must be right, thought goes, even though any sober observer knows his true motivation is to preserve the success of his company (and his own income) -- not to establish a safer financial system. That makes him incredibly dangerous.

Now Buffett appears to be using his god-like reputation in similar ways.

Just as we're gaining momentum in the battle to regulate the unruly world of derivatives, The Wall Street Journal reports that Buffett and other Berkshire employees are close to getting Congress to insert a provision into pending financial reform that would exempt certain existing derivatives contracts from being forced onto exchanges. Among other things, moving onto exchanges would require derivatives counterparties to post adequate collateral, lest we end up with another AIG.

Hence the reason Berkshire is lobbying. As the Journal notes, pending legislation would force the company -- which owns some $63 billion in derivatives -- to pony up billions of dollars in collateral that might not be necessary given its ironclad balance sheet. "Berkshire Hathaway argued that it shouldn't be made to redo existing contracts and that it is already healthy enough to cover its obligations," the Journal says.

Which is true ... for Berkshire. But what about everyone else? What about the existing idiots running around with trillions of dollars of dynamite in their mouths? Many of them could be left free to run wild if this provision goes through. In an attempt to fight against what might seem unfair for Berkshire, Buffett could water down a bill that leaves the radioactive world of existing derivatives considerably untouched.

And don't underestimate how much money we're talking about here. Have a look at the top five banks' notional derivatives exposure, as shown in the Office of the Comptroller of the Currency's latest report:

Bank

Notional Derivatives Exposure,
Dec. 31, 2009

JPMorgan Chase

$78.7 trillion

Bank of America (NYSE: BAC  )

$72.5 trillion

Goldman Sachs (NYSE: GS  )

$48.9 trillion

Morgan Stanley

$41.5 trillion

Citigroup (NYSE: C  )

$39.3 trillion

Source: OCC, Dec. 31, 2009.Notional value is the total value of a leveraged position's assets.

That's trillion, not billion. The total notional derivatives exposure held by the top 25 banks is over one-quarter of a quadrillion dollars (no joke). Most of these are interest rate swaps that aren't as combustible as the credit-default swaps that nearly ended the world. Yet substantially all of them (96.1%, to be exact) are not processed on exchanges where counterparties can be assured the guy on the other side of the trade isn't a deadbeat, as AIG was.

Anything of this size left to its own devices can, and eventually will, start wreaking havoc. Ironically, it was Charlie Munger, Buffett's sidekick, who once warned that the staggering notional value of interest rate swaps makes them inherently dangerous, even if they give off a relatively safe facade.

About that ...
There's one more Munger comment that puts Buffett's lobbying efforts in perspective. At last year's Wesco Financial shareholders meeting, a questioner asked Munger whether it was fair that Wells Fargo (NYSE: WFC  ) was forced to participate in the TARP bank bailout program even when it didn't need the help. Munger replied that no, it wasn't fair, but Wells should "accept its medicine" for the good of the system, even if it hurt the company.

When it comes to derivatives, Berkshire should do the same.

Fool contributor Morgan Housel owns shares of Berkshire Hathaway, which is a Motley Fool Inside Value recommendation and a Motley Fool Stock Advisor pick. The Fool owns shares of Berkshire Hathaway, and has a disclosure policy.


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  • Report this Comment On April 27, 2010, at 12:50 PM, knighttof3 wrote:

    BRK is an exceptional company, but you cannot make law based on exceptions. As a rule the 2008-9 meltdown proved that the tail wags the dog; that threatening "we are too big to fail" will make the government and the Fed pour billions of dollars into your coffers; that we are born to serve the interests of the financial industry to the extent of putting our kids under a huge debt burden; they are kings and we are serfs. Any law that tries to go on the opposite direction gets my vote.

  • Report this Comment On April 27, 2010, at 1:03 PM, davidfhadley wrote:

    I think you are missing the point. The point here is not that Buffett deserves a special exception, the point is that it is not proper for the government to intervene in existing contracts.

    Take a different example without the word "derivative." Given what we have learned about the credit risk of sub-prime mortgages, the government could pass a law requiring that all sub-prime mortgages be 10% cash collateralized by the borrower. Of course that is terribly unfair to the borrower. So why is it fair to Berkshire (or anybody else with an existing derivatives contract) to require them to put up collateral when the counterparty didn't require it in the first place? It's not.

    Apply the new law to new contracts, but not to existing ones. That simple.

    Full disclosure: I also own BRK stock.

  • Report this Comment On April 27, 2010, at 1:06 PM, Ellisee wrote:

    Buffett just doesn't want to have the terms of his equity puts changed after the fact.

    He entered into deals based on the ability to invest the money until the contracts are settled.

    If he has to post collateral, the deal doesn't make sense, and he is already in the deal.

    you see?

    It's like you pay me a hundred bucks, and I get to invest it for twenty years, and I'll pay you three hundred in twenty years if something bad happens.

    Sure, I'll take that bet, because the bad thing is unlikely, and furthermore, I can triple the hundred in twelve years by investing it.

    Now the government comes in and says that I have to give you sixty bucks in collateral on that deal that we did last year.

    Now the deal makes no sense, because I have only forty dollars to invest.

    Now, if you decide that the deals made in the past need collateral, then you have to give the deal makers a chance to unwind the no longer economic deals, and here is the problem, how do you unwind a deal that has happened in the past?

    You can't pass retroactive laws.

    Let the banks slowly replace their outstanding positions over time with collateral on exchanges.

    The bets Buffett is concerned with have to do with long dated put contracts that he never would have entered if he had to post collateral.

    they only make sense when he gets to invest the put buyers' money.

  • Report this Comment On April 27, 2010, at 1:09 PM, nuttincowboy wrote:

    I'm so with you on this one, Morgan!

    I was stunned & disappointed to hear of Warren Buffett standing up for what he calls "financial instruments of mass destruction".

    What's good for the goose is good for the gander. Old wisdom; but as true in Omaha is it is on Wall St.

  • Report this Comment On April 27, 2010, at 1:10 PM, sdm1177 wrote:

    The five banks listed in the table above already total $280 quadrillion - which is more than "one-quarter of a quadrillion dollars". I can only imagine how much the 25 top banks total....

    Perhaps Mr. Buffett has a point about the grandfather clause. New contracts should be listed. But what to do about all that money out there that is questionable? I know, you only have to redo the contracts if you stock sells for less than $100K per share.

  • Report this Comment On April 27, 2010, at 1:14 PM, TMFHousel wrote:

    sdm1177,

    "The five banks listed in the table above already total $280 quadrillion - which is more than "one-quarter of a quadrillion dollars"

    To clarify, the top 25 banks hold $299 trillion. The top five, as shown in the table, hold $280 trillion, as you pointed out ... or essentially all of 'em.

    Morgan

  • Report this Comment On April 27, 2010, at 1:17 PM, TMFHousel wrote:

    Thanks for the comments all,

    I agree that Buffett doesn't want the contract terms changed after the fact. But to use that as an excuse to leave a $600 trillion market unchecked is unreasonable. That's where Munger's quote at the end comes in -- yes, it sucks for Berkshire, but it's the right thing to do for the financial system.

  • Report this Comment On April 27, 2010, at 1:21 PM, ron153 wrote:

    You are incorrect. It would be very disrputive to markets to intervene in contractual agreements that have already been legally put into place. It is also highly inappropriate. What contracts can be trusted if the government can come in after the fact and modify them? How would institutions in other countries view this sort of action? It would be a very dangerous precedent. To imply that Buffett is self-serving here means that you understand nothing about the man.

    Ron Beasley

    www.rwbi.net

  • Report this Comment On April 27, 2010, at 1:28 PM, TMFHousel wrote:

    For what it's worth here folks, Congress just denied Buffett's provision.

    http://online.wsj.com/article/SB1000142405274870346520457520...

  • Report this Comment On April 27, 2010, at 1:49 PM, knighttof3 wrote:

    I am not buying it. No one is changing the existing contract. All you need is the ability to prove that you are good for your bets. Exactly the scenario that caused the meltdown.

    Banks deal with changing requirements for cash reserve ratio all the time (basically to prove that they can pay out 10 c on every dollar of deposits tomorrow, if need be). Similarly, if you buy stock on margin, you have to post collateral. Same if you're an insurance company betting on people's mortality and car accidents. Why should derivative traders have different standards?

  • Report this Comment On April 27, 2010, at 2:22 PM, Teraax wrote:

    I think it really comes down to the wording of the bill.

    If the bill simply states you have to have cash reserves availible to support your derivitives, then I agree with knighttof3. There would be no changes to the contract itself.

    However, if the bill states that the contract will now include the amount of cash that needs to be held, that would be amending the contract and a bad precedent to set.

    I have been trying to find the bill. All I seem to come up with is summarys on opencongress.org. Anyone know if the full bill is out there and how to get ahold of it?

  • Report this Comment On April 27, 2010, at 2:27 PM, plange01 wrote:

    jpm is way over priced! citi is a far better stock if your looking to make money this one shoukld easily triple in the next year...

  • Report this Comment On April 27, 2010, at 2:46 PM, TheDumbMoney wrote:

    TMFHousel, I see that Buffet's provision was rejected. But there is of course the possibility that, because of the amounts at stake, it is simply impossible for these old contracts to be brought out in the open, assuming a certain amount of reserves must be posted (I don't know the details of that).

  • Report this Comment On April 27, 2010, at 2:55 PM, TMFBane wrote:

    Excellent article, Morgan! I couldn't agree more, and I'm a Berkshire shareholder too.

  • Report this Comment On April 27, 2010, at 3:11 PM, ckfinance2003 wrote:

    Actually I'm more disappointed Berkshire is involved with the derrivatives than anything...but on some level I understand the argument that this may have the potential to change contracts mid-stream which is an ugly proposition.

    I'd prefer if in the lobbying they'd have proposed an alternative solution to round up the existing "toxic derrivatives without penalizing the current parties unnecessarily; but still bringing them under control so the don't tank things later.

  • Report this Comment On April 27, 2010, at 3:18 PM, dward22 wrote:

    There is no guarantee that the legislation would not be enforceable outside of the United States. All existing derivatives agreements would need to be modified to take into account the new US laws. While I understand the need to keep regulate, I don't think it is realistic to change existing deals unless you focused on particular products like Credit Default Swaps. Even then, I can't see this law being enforceable for years because of the legal changes and logistical changes that would need to take place to get companies capable of complying.

  • Report this Comment On April 27, 2010, at 3:41 PM, Melaschasm wrote:

    If we are going to retroactively change collateral requirements on derivatives, why not retroactively tax every blog post for the past decade. Just think how much revenue could be raised with a $1 per blog posted.

  • Report this Comment On April 27, 2010, at 3:54 PM, NeedaClue7 wrote:

    How about the counterparties that stand to reap benefits that were never bargained for?

  • Report this Comment On April 27, 2010, at 4:43 PM, THEcoletrain wrote:

    Government changes contracts all the time. Its called bankruptcy...

  • Report this Comment On April 27, 2010, at 5:30 PM, chukarlady wrote:

    There are more insurance company shenanigans coming from USAA. They are asking military people, past and present, to lobby for them as they attempt to get an exemption from the Volcker rule. One of their arguments to their members is that they can be trusted because they didn't need to take TARP money. I used to trust USAA and now I don't after this underhanded tactic. I don't believe they have my interests as a member in mind in going before Congress. I think they only care about their convenience and their compensation packages.

  • Report this Comment On April 27, 2010, at 5:35 PM, triple26n30 wrote:

    Anybody think Buffet received the deal of a lifetime from Goldman because they blew up AIG?

  • Report this Comment On April 27, 2010, at 6:01 PM, Celtics17 wrote:

    Hey Warren, how's all that money you donated to ObaMarx and his Democrat Comrades working out for you? HAHAHAHAHAHAHA.

  • Report this Comment On April 27, 2010, at 6:38 PM, NotJesseL wrote:

    There does come a time when government needs to intervene in existing contracts. What about the civil war, when the Union nullified the property value of all those slaves? Not exactly the same thing here, but some things are more important than contract law.

  • Report this Comment On April 27, 2010, at 7:16 PM, penchy1 wrote:

    I understand the sentiment but this smacks of communistic ideas! We will hamstring the best and productive to help the worst or ineffiecient. Definitely a Marxism theme here. I like the ObaMarx comment from Celtics17.

    Mark, ever vigilant for those who want more of my money.

  • Report this Comment On April 27, 2010, at 9:01 PM, xetn wrote:

    What a sick idea! The very thought of new regulation will somehow do what the existing ones did not do is plain wishful thinking. But my main issue is: Just who held a gun the the head of anyone buying these so-called assets? They all bought because they relied on a sales pitch and did not take the time or trouble to check them out independently. If they had they would probably not purchased them. But you regulation lovers believe it is the public's responsibility to protect them against themselves (since they are too stupid to know better).

    And you wonder why almost every major company has off-shored jobs. There are over 80000 pages of existing regulations in existence now (not including the garbage called ObamaCare). All of that existing regulation adds over $6000. to the cost of business in the US for every man, woman, and child.

    This same argument is always used: if this (fill in the blanks) regulation didn't work, this new one will. Yeah, right!

    I just love the idea of Obama going on the trail of GS after receiving his biggest campaign contribution from them; and filling his administration with former GS'ers.

    As for NotJessel, What stupidity! First the Civil War was not fought to free the slaves, it was fought to maintain the North's source of revenue: the South! Lincoln did not give a damn about the slaves and even voted to keep them from being able to vote! Second, if you don't believe in contract law, then we don't have any basis for trade. This country is supposed to be based on a rule-of-law. Of course the Supreme Court doesn't agree with that idea having stuck down the law of contracts regarding bond holder's rights in the Chrysler and GM cases.

  • Report this Comment On April 27, 2010, at 9:42 PM, FuerteFunds wrote:

    At the end of the Michael Moore movie "Capitalism: A Love Story" in the credits there are some cogent quotes, one by Mr. Warren Buffett, " In class warfare, my class is winning but shouldn't be." An interesting movie overall but one question to Mr. Moore "How do you finance your movies?"

  • Report this Comment On April 27, 2010, at 10:39 PM, Foolfor7 wrote:

    It might be interesting to compare the size of these contracts to the GDP of the world. Most sources put this number at $57 trillion to $60 trillion. So, the top 5 banks combined are making bets that equal over 4X the world's GDP. Now that's scary. Much scarier than requiring that the banks (and companies) hold reserves to cover these bets.

  • Report this Comment On April 28, 2010, at 12:27 AM, bohlmanch wrote:

    Okay... Let's not heap reward on the responsible parties who knew what they could handle.

    Let's see what happens when we ask the less responsible parties to pony up for all of their POSSIBLE losses. Gentlemen, please bring this to the cashier right now or unwind all of your deals immediately. (Of course, you would need to find a counter-party to unwind them to but that should not be difficult... Right?

    Bank

    Notional Derivatives Exposure,

    Dec. 31, 2009

    JPMorgan Chase

    $78.7 trillion

    Bank of America (NYSE: BAC)

    $72.5 trillion

    Goldman Sachs (NYSE: GS)

    $48.9 trillion

    Morgan Stanley

    $41.5 trillion

    Citigroup (NYSE: C)

    $39.3 trillion

  • Report this Comment On April 28, 2010, at 12:32 AM, predfern wrote:

    Derivatives do not create risk, they just transfer it. A second party is paid a fee to assume the risk. They are economically productive because companies can transfer risk of economic disruption. Properly used, derivatives reduce financial risk. Obama's proposal is the wrong tool and will make things worse. See

    The Truth About Derivatives

    Published on April 22, 2010

    by Dave Mason

    http://www.heritage.org/Research/Commentary/2010/04/The-Trut...

  • Report this Comment On April 28, 2010, at 12:41 AM, ybckorea wrote:

    Derivatives example.

    I put house up for sale.

    Buyer emerges.

    I buy life insurance on buyer.

    I buy insurance on sale price that guarantees price if sale does not go to settlement.

    Buyer dies - I get insurance on dead buyer and insurance on non-settlement. I now have twice my house price and my house.

  • Report this Comment On April 28, 2010, at 12:50 AM, Ruhaan wrote:

    You say 96% of these are interest rate swaps which are inherently safe. Now do the math...96% of 280 Trillion ~ 268 Trillion of the safe kind.. Now 12 Trillion of the non safe kind.. Still a very large number but not as alarming as you made it sound. Great article nonetheless.

    There have been posts that have made this point about changing the contracts after they have been enetered akin to changing the goal post once you have scored.. So no I dont think Warren Buffet is wrong in trying to influence the legislation draft.

    Heres my analogy.. you cannot retroactively punish someone of there past acts by some new law.. if those acts were deemed as not crimes in the time they were committed by that society..

  • Report this Comment On April 28, 2010, at 1:02 AM, TMFHousel wrote:

    "You say 96% of these are interest rate swaps which are inherently safe. Now do the math...96% of 280 Trillion ~ 268 Trillion of the safe kind"

    Actually, I said inherently *dangerous.* That's different than safe.

  • Report this Comment On April 28, 2010, at 3:38 AM, SnapDave wrote:

    Anyone know how much money would be required to be set aside? If Berkshire needs $6-8B set aside for $63B (notional value?) that's 10-13%. Does that mean JPM would need to set aside $8T or C $4T? Obviously they don't have that much money.

  • Report this Comment On April 28, 2010, at 4:52 AM, robcerra wrote:

    How many times do we have to get hit on the head before we realize that the game is rigged for the rich,poweful and insiders.

    Our regulators were aspleep at the switch and/or turning a blind eye to the financial problems that were slowly mounting.

    We need a general housecleaning not more regulations.

  • Report this Comment On April 28, 2010, at 10:33 AM, RaplhCramden wrote:

    I wonder if anyone against Buffett has read what is in the legislation, or Buffett's brief comments about it (reported in Omaha paper, I think).

    Buffett points out that an options contract with collateral costs more than an options contract without collateral. Both contracts have existed in the past. As Buffett suggests, when offering a client a choice between an 8 ounce and a 12 ounce steak, if they pay for the 8 ounce steak, it doesn't make a lot of sense for the government to come along a few years afterwards and mandate delivery of the 12 ounce steak.

    Further, the collateral requirements are three-ways moronic:

    1) Cash collateral, which is simply punitive, why not allow some real investment options writer has to be sequestered as collateral, with multipliers similar to margin requirements: perhaps posted at 200% of required collateral amount, requiring additional capital when it falls below 140% of required collateral?

    2) Separate Collateral on EACH position, not on net exposure. So I sell a call and an offsetting put, my actual exposure is minimal, the government requires TWICE as much collateral as if I just sold the call and had real exposure? Since when is stupidity good policy? Since we started the senate, that's when.

    3) It doesn't matter if derivatives fail. What matters is if regulated entities are allowed to count derivatives in their capital base for meeting required ratios. The problem isn't that subprime mortgages failed. The problem is that regulators abdicated the responsibility for insuring strong capital bases to Moodys and S&P, who proceeded to fool themselves, and make good money doing it, that they understood the risks of a new-fangled tranched security so well that they could assign highest ratings to it. Rationally, a security can't be rated that high until its type has existed at least 30 years, so that we actually have KNOWLEDGE about how it performs.

    What is needed is limitations on the regulators so that regulated (i.e. "too big to fail") entities are protected. Trying to stop unregulated entities to fail is to thwart the "creative destruction" necessary for progress in technology and business.

  • Report this Comment On April 28, 2010, at 12:07 PM, redhead77 wrote:

    The sentiment of the article is correct, but I agree with DavidFHadley. You can't establish the precedent of reaching into existing financial contracts and forcing a change in terms. I suspect that is all that Buffet wants.

    Clearing is a more secure approach, but it ties up much more capital.

    So the big banks often do bilateral deals where they look at one another quite closely all the time. These guys keep very good track of their known counterparties through their credit departments. The contracts are generally written so that if the credit quality of the guy on the other side goes down, then that guy has to post collateral or buy a bigger letter of credit to cover the additional exposure. This system uses less capital than clearing and leaves more funds for other purposes. That is why it is preferred to clearing in many cases. But clearing is safer.

    Another issue with how Morgan wrote the article: the notional value of all the derivatives is not the net value of all those derivatives. That trillions of dollars thing is a bit of hyperbole in the sense that in a meltdown, a good number of them will move in opposite directions, like owning a put and a call on the same stock. The total notional makes for interesting copy when writing a story. It is the easy number to look up. But it is not an accurate portrayal of risk held by those institutions.

    I think RalphCramden missed the point on the value of clearing: if you have a call and a put, the clearing system would require moving capital from one position to the other as they change in value every day. You wouldn't have a margin call unless your overall net value approaches some limit.

  • Report this Comment On April 28, 2010, at 12:16 PM, TMFHousel wrote:

    redhead77

    Thanks for your comments.

    "Another issue with how Morgan wrote the article: the notional value of all the derivatives is not the net value of all those derivatives .... The total notional makes for interesting copy when writing a story. It is the easy number to look up. But it is not an accurate portrayal of risk held by those institutions."

    I think I made it pretty clear that 1) this is the notional, not net, value we're talking about, and 2) the bulk of the notional numbers are IR swaps that aren't nearly explosive as people make them out to be. What's true, as Munger noted, is that even if the offsetting nets depresses most the risk,you don't have to be off by even a hair to start causing problems when you're dealing with numbers this large. That brings up point number 2:

    "a good number of them will move in opposite directions, like owning a put and a call on the same stock"

    Except when they don't. See LTCM in 1998.

  • Report this Comment On April 28, 2010, at 12:27 PM, afamiii wrote:

    I don't know why we make simple things sound complex. The meltdown was caused by too much leverage (Lehman, GS and others were regularly at 40 to 1). Historically 'banks' and 'some' other financial institutions were not allowed more than 12 to 1. This was increased due to their lobbyist (and friends in Government.)

    If congress were to ask home owners to post extra equity (collateral) on their existing mortgage loans, because too many home owners (counter parties) had defaulted on their payment obligations and caused a financial meltdown, their would be a brand new congress at the first available opportunity.

    Not just because they would be wrong, but because they would also be stupid. You don't retrospectively ammend contracts to favour one party unless you are a Russian.

  • Report this Comment On April 28, 2010, at 1:14 PM, susan400 wrote:

    You are "calling him" ?

    your know nothing & he isn't listening.

    Some get kicks from trying to be clever but are NOT.

    susan400

  • Report this Comment On April 28, 2010, at 2:25 PM, freunddoggy wrote:

    Simply enforce this rule on NEW DERIVATIVES CONTRACTS, and let the market deal with the old ones. Will it be painful? Possibly. But at least the leak is plugged.

  • Report this Comment On April 28, 2010, at 5:34 PM, WyattJunker wrote:

    Neither prop desk trading or derivatives caused the damage. They may have exacerbated it, but then again that's just the symptoms we are dealing with here. Liar loans which were bundled up, then sliced into new "AAA products" then sold to foreign governments caused the problem once the false ninja loans began to unravel. And those loans are all the product of Fannie and Freddie aka Frank and Dodd.

    Everything else, including this faulty bill, addresses the wrong thing, which is kind of what I think Frank and Dodd want all along.

    Hey, did Obama give back his million dollar Goldman Sachs check yet? Just checking.

  • Report this Comment On April 28, 2010, at 5:37 PM, WyattJunker wrote:

    They aren't 'contracts' if the government breaks them.

    But I'm starting to see a pattern here with this government.

    They broke the commitment to the GM bond holders in order to give that money over to the union.

    This is Chicago/Venezuela style politics. And the inability to honor financial contracts will kill this market faster than any derivatives reform.

  • Report this Comment On April 30, 2010, at 2:22 PM, cgscouten wrote:

    Let derivative contracts legally entered stand. Government should allow these to unwind naturally, However, given their obvious systemic danger, future synthetic derivatives ('naked' derivatives) should be banned. Only derivatives that represent insurance on assets actually held should be permitted. Other countries may not adopt these rules, but US firms should be banned from trading in those markets - just as the Foreign Corrupt Practices Act bans bribery abroad by US firms. Secondary point -- existing derivatives should be registered - party, counterparty and amount - and unwound either by expiration or by trading on an open exchange, just as new derivatives are.

  • Report this Comment On April 30, 2010, at 4:37 PM, RaiddinnRZ wrote:

    On April 28, 2010, at 12:41 AM, ybckorea wrote: buy insurance on house buyer and so on

    I just wanted to say that you can't buy life insurance on somebody else in any place that I am aware of unless it involves businesses. Selling a house doesn't.

    You lose nothing if such a buyer dies since you get to keep your house, therefore you have no possibility of loss so insurance industry regulations should easily smack that down.

    You also can't double insure the same thing. By that I mean 1 contract worth 2 mil is different than 2 contracts each worth 1 mil, the former being legal and the latter not.

    I am pretty sure that insurers would hear about this scam and give you back your purchase price rather than making the multiple payouts. They might even bring suit against you for fraud while they were at it.

    The actual industry centered around writing insurance when people have insurable interests is very highly regulated. That is unlike the market for derivatives contracts. Because insurance companies do both doesn't mean they are mixed or that the same rules apply to both.

    Also, I very much support companies having to prove insurable interest on their derivatives contracts just like they have to prove insurable interest when they write their main line business contracts.

  • Report this Comment On May 01, 2010, at 1:14 PM, oji wrote:

    It's about time people start looking at Buffet for who he is - a mere mortal. Either he's playing the fool for friends, or he has something to hide.

  • Report this Comment On May 02, 2010, at 11:29 AM, dhuddle wrote:

    I agree. Good article. Thanks for writing it.

  • Report this Comment On May 02, 2010, at 1:22 PM, miggie2819 wrote:

    I fully understand the argument, both legal and fairness that existing contracts should not be retroactively changed, other than by agreement of the parties to the contract. Nonetheless, when you add the modifier "WMD" to the mix, perhaps we have an animal of another stripe. In order to recognize the legal and fairness principles while acknowledging the severity of the issue, why not try an lesser capital requirement for existing derivatives. Alternatively, apply the capital requirements for existing derivatives over a longer period of time. Did President Clinton do any more when he retroactively passed a tax increase and offset some of its impact by allowing two years to pay the tax due. In fact, don't almost all tax changes have some aspect of altering the nature of existing contracts? So then, what we are really talking about is degrees of altering existing contracts.

    Perhaps all or nothing is not the only approach for WMD's. In fact, why didn't Mr. Buffet or Senator Ben Nelson make a less than all or nothing suggestion rather than underscore what some might see as a disingenuous position.

  • Report this Comment On May 02, 2010, at 2:11 PM, rickcfp7 wrote:

    Just a quick comment on the size of all the derivative exposure of the top 5. On a gross basis these numbers are large, what is more difficult to ascertain from these figures is the cross-agreements made between them. When I worked on the desk, we had many agreements that we monitored for counterparty risk, often netting the owed and owe to calculate our true risk. As some have mentioned in other context, the rewards to some will be the opposite to the other in the various events that are "hedged/speculated" on these instruments. It's not like a an event is going to suck $250T out of the market.

  • Report this Comment On May 02, 2010, at 2:20 PM, TMFHousel wrote:

    Thanks again for the comments, all.

    Another note on the size of derivatives. Again, the trillion/quadrillion numbers referenced here are notional numbers. Most of the contracts, as rickcfp7 notes, net each other out. But as Munger once mentioned, the sheer size makes them inherently dangerous if and when they don't work out as planned. If a fraction of 1% backfire and don't net out or perform as expected, basically, we're screwed. If there's one thing we should have learned from the past three years, it's that when Wall Street brandishes something huge and complex and assures us everything is fine and safe, it's probably not.

  • Report this Comment On May 04, 2010, at 12:20 PM, madmilker wrote:

    He was wrong on this too...

    on Wal*Mart's China web page!

    "Wal-Mart China persists in local procurement which provides more job opportunities, supports local manufacture industry and promotes local economy. So far, 95% of merchandising sold at Wal-Mart China store are local products by which Wal-Mart has established business relations with nearly 20,000 suppliers. At Wal-Mart, we treat suppliers as partners and would like to develop with them. In 2008 Wal-Mart won the Supplier Satisfaction published by Business Information of Shanghai for five consecutive years."

    5% foreign

    That is a slap in the face to all Americans.

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