Economic Apocalypse Is Nigh [Warren Buffet]

Daily Telegraph ^ | March 3, 2003 | Simon English

[AntiGuv]

Warren Buffett is poised to issue his most doom-laden forecast for the state of the world economy yet, including a damning verdict on the derivatives industry he fears could cause a global financial crisis.

In the upcoming annual letter to shareholders of Berkshire Hathaway, Mr Buffett drops his usual folksy style to warn that banks do not understand the hidden risks lurking on their balance sheets.

He labels derivatives "time bombs, both for the parties that deal in them and the economic system" and "financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal".

The views of the world's second richest man are closely watched and his apocalyptic vision will do little to steady nerves on Wall Street or in the City of London. Extracts from his annual letter, to be delivered on Saturday but posted on Fortune.com yesterday, reveal that he has little optimism for the stock market.

"Despite three years of falling prices which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us. That dismal fact is testimony to the insanity of the valuations reached during the Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge," he writes.

Until now vague warnings about the pyramid nature of derivatives contracts have led to bland assurance from banks that there is no threat to their stability.

Mr Buffett says the banks simply have no idea what their exposure could be. "When Charlie [Munger, his business partner] 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."

Derivatives are often complex financial instruments that allow investors to take bets on anything from share prices to the weather. Their range is limited, says Mr Buffett, "only by the imagination of man, or sometimes, so it seems, madmen". Enron was especially fond of derivatives, offering contracts that would be settled years in the future and claiming profits immediately.

Berkshire Hathaway acquired a derivatives dealer when it bought reinsurer Gen Re. After failing to sell this business, Mr Buffett is now closing it down though he admits this will take years. "Reinsurance and derivatives businesses are similar. Like Hell, both are easy to enter and almost impossible to exit," he says.

Mr Buffett, dubbed the Sage of Omaha, believes that major insurers are exaggerating earnings from derivatives contracts and underplaying the "daisy chain risk" that comes when they lay off business with other firms.

His personal fortune fell last year by $5 billion to $30 billion, leaving him second to Bill Gates in the rich list.

[Grand Old Partisan]

If Buffett really believes this, he would have sold every share and shorted the market.

[AntiGuv]

Warren Buffett. Need to work on the spelling thing...

[Arkinsaw]

I appreciate his insight, but not his candor at this juncture. If the only thing holding up the table is a leg made of balsa, why kick it out?

[PoisedWoman]

Buffey the Economy Slayer?

[ShadowAce]

Except--Neither his hostory nor his reputation indicate the views you have expressed. His is one opinion I do pay attention to.

[RightOnline]

Maybe, but he's one smart sumbitch. I'd listen to him carefully.

[Lancey Howard]

His is one opinion I do pay attention to

...he's one smart sumbitch. I'd listen to him carefully.

Yep.

[tictoc]

Berkshire Hathaway acquired a derivatives dealer when it bought reinsurer Gen Re. After failing to sell this business, Mr Buffett is now closing it down though he admits this will take years. "Reinsurance and derivatives businesses are similar. Like Hell, both are easy to enter and almost impossible to exit," he says.

I'm not touching that one :-)

[irish_links]

"....Until now vague warnings about the pyramid nature of derivatives contracts have led to bland assurance from banks that there is no threat to their stability.

Mr Buffett says the banks simply have no idea what their exposure could be......"

Clearly, Mr. Buffett has been observing his equally unctious breathern Mr. Soros, and admiring how much positive press he is getting spewing anti-capitalist mish mosh. Most of this letter is hockum, just as much else spoken by Mr. Soros and Mr Buffett has been after they discovered the strange (and profitable) new respect they've received since they took a left turn.

The major banks engaged in derivatives trading are quite good at managing the risks in their portfolios and well aware of the nature and magnitude of these risks. Where Mr. Buffett is correct is when he warns that portfolios are not properly marked-to-market. Derivatives by their very nature are customized, non-commodity assets. No liquid trading market exists for a particular derivative from which to determine its true price. Thus, the traders themselves are permitted to functionally value their own positions. Surprise, surprise, many fudge the prices to their own advantage.

This is an age old game on the Street. It brought Kidder, Peabody to its knees twice, once with Treasuries and the other with REMICs/CMOs. Its been the ruin of a number of other firms.

A good compliance/internal audit function can stay on top of the problem. This is no reason to stop dealing in derivatives. It is reason to be ever vigilant.

Mr. Buffett should shut up and trade stocks. It is a shame that so many people see him as some sort of magician. He is more like the Wizard of Oz.

[Arkinsaw]

His is one opinion I do pay attention to.

Enough to make a run on the bank and yank out your money? Not sure of how his statements will improve things in our current state. Sawing off a rotten limb is okay unless the entire banking system rests on it. In that case he might step a little lighter.

[Rockitz]

He doesn't want to create panic in his own stock. He may, in fact, be buying puts or selling calls on his personal shares as a portfolio protection and be shorting the market. I'm not even sure he is required to report his option activities. Does else anyone know if so-called insiders (officers of the corporation and major shareholders) are required to report option activities? I have asked my friends who are brokers many times and have gotten no response.

[Clinging Bitterly]

>> smart sumbitch...

He predicted D.C. was going to be nuked about a year ago. I remember the stir that created, which was none at all. The market will respond to his recent prediction likewise - muttering about tinfoil and going about their business.

Dave in Eugene

[ChadGore]

What a line: Like Hell, both are easy to enter and almost impossible to exit

[general_re]

"Reinsurance and derivatives businesses are similar. Like Hell, both are easy to enter and almost impossible to exit," he says.

Yeah, that's what I...heyyyyyy, watch it, pal ;)

[ffusco]

How true. These guys can push the sails of the market with their breath, to their advantage. What debt heavy company is he trying to buy chaep?
A more benign possibility:Perhaps old Buffett is vying for Greenspan's seat.
PS reading Soros on Soros this week.

[Nick Danger]

If Buffett really believes this, he would have sold every share and shorted the market.

He probably can't. Buffet rarely buys thinly into anything. If he buys at all, he goes for control. He doesn't buy "stocks" so much as he buys companies.

Because of this, he has to improve the performance of an acquisition by quite a bit before he can sell it. Think about it... who wants to buy a stock that Warren Buffet is dumping? If it had a future, he'd keep it. And it's not just some guy with 2% of the shares selling out... almost the whole market cap will be for sale. The only way he ever gets out is to buy control at $10, run it up to $70 or $80, and then sell out at $40 or $50.

The good news for Buffet is that he stays away from anything exotic. I'll bet he owned zero shares of dot-coms. He buys things like brick companies, and guys who make cardboard boxes... basic stuff that never goes away.

[ffusco]

Perhaps the Enron situation was the critical moment where the divergence (to paraphrase Soros) between reality and perception f became apparent to the investor. On a personal note my father who has been semi-retired for years was very shaken by the though of "all those Enron folks who lost their retirement." We shall see.