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:


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.