If Warren Buffett didn ’t know that, w hat kind of Oracle is he?

[Cees Binkhorst]

REPLY TO: D66 at nic.surfnet.nl

Om de bedrage enigzins in perspectief te krijgen:
World's real estate is estimated at about $75 trillion
World's stock and bond markets is more than $100 trillion
BIS valuation of world's derivatives back in 2002 was $100 trillion
BIS 2007 valuation of the world's derivatives is now $516 trillion

Groet / Cees

Warren Buffett's Hidden Stake in Financial Weapons of Mass Destruction
by Edward Jay Epstein
February 2, 2009, 12:03 PM
http://www.vanityfair.com/online/daily/2009/02/warren-buffetts-hidden-stake-in-financial-weapons-of-mass-destruction.html

In the presidential debates in October, both Barack Obama and John
McCain came up with the same name to save the reeling American economy:
Warren Buffett, the 78-year-old chairman of Berkshire Hathaway, a $120
billion holding company. Known in the media the “Oracle Of Omaha,”
Buffett had condemned derivative contracts as early as 2003, describing
them as “time bombs, both for the parties that deal in them and the
economic system.” After derivative contracts on subprime mortgages had
delivered a near death blow to the financial system, in October 2008, he
told Charlie Rose in an hour-long televised interview that such
derivatives were nothing short of “financial weapons of mass
destruction,” saying, “They destroyed AIG. They certainly contributed to
the destruction of Bear Sterns and Lehman.” It light of his lucid
explanation of their incredible perils, it seemed gratuitous for Charlie
Rose to then ask Buffett if he himself had trafficked in derivatives. If
he had asked, Buffett’s answer might have been surprising, since, at the
time of that interview, Buffett’s holding company not only had
multi-billion dollar positions in derivative contracts but was the
largest single shareholder in one of the principal enablers of the
proliferation of subprime mortgage derivatives.

As subsequently revealed in Berkshire Hathaway’s third-quarter 10-K
filing with the S.E.C., in 2008, the Oracle turned out to be one of
America’s largest sellers of derivative contracts.

He sold more than $2.5 billion worth of credit default swaps in 2008—the
same notorious derivative contracts that had brought AIG to its
knees—and more than $6.7 billion worth of another type of derivatives,
called “index put option contracts,” which essentially bet stock prices
would not fall here and abroad. These contracts have a duration of as
long as 20 years, and, as the disclosure notes, “generally may not be
terminated or fully settled before the expiration dates and therefore
the ultimate amount of cash basis gains or losses may not be known for
years.” In the first nine months of 2008 alone, Berkshire’s losses from
these derivative amounted to $2.2 billion.

But Buffet’s involvement in the derivatives casino went beyond selling
credit default swaps and put options. After Moody’s Corporation, the
second largest credit-rating company, went public, in 2000, he had
Berkshire Hathaway buy 48 million shares—approximately a 20 percent
stake—making it by far Moody’s largest shareholder. The role that
Moody’s and its fellow rating agencies, Standard & Poor’s and Fitch
Ratings, were to play in the proliferation of subprime mortgages is
lucidly described by Nobel laureate economist Joseph E. Stiglitz in an
interview with Bloomberg News: “I view the ratings agencies as one of
the key culprits. They were the party that performed that alchemy that
converted the securities from F-rated to A-rated. The banks could not
have done what they did without the complicity of the ratings agencies.”

The sad history of Moody’s race to the bottom began after it was spun
off by Dun & Bradstreet Corp., in September 2000, and after Buffet had
invested $499 million in it. Prior to that, Moody’s was a stodgy company
in the low-profit business of evaluating credit data supplied to it
largely by Triple A companies. The S.E.C. had given it, along with S&P
and Fitch’s, an effective lock on the issuance of credit ratings. So the
giant corporations were required to get its top rating (AAA, meaning
little or no risk) in order to sell their bonds to insurance companies,
pension funds, and other regulated institutions. But with the
mushrooming of mortgage-backed securities, Moody’s found a much more
profitable business line: rating pools of mortgages called
collateralized debt obligations (C.D.O.’s).

Working on the theory that if these C.D.O.’s were structured into
different tiers, it could award Triple A ratings to the safer
tiers—which, in turn, would allow underwriters to sell C.D.O.’s to
institutions—Moody’s made additional money advising the underwriters how
to structure their C.D.O.’s in such a way that it could provide top
ratings. Once they received these ratings, the underwriters could
leverage them over and over again via so-called piggyback loans. Even
though subprime mortgages accounted for about half of the collateral on
C.D.O.’s, Moody’s managed through this theory to assign Triple A grades
to nearly 75 percent of them. In August 2004, to get an even larger
share of this business, it revamped its credit-rating formula so that it
could issue top-ratings to an even larger portion of subprime debt. Not
to lose market share, its chief competitor, S&P, followed suit the next
week.

By 2006, the market for rated C.D.O.’s had exceeded $3 trillion. This
enterprise entailed an obvious conflict of interest, since Moody’s was
being paid by the very companies it was rating, but the profits were so
enormous that such questions were overlooked by everyone involved. The
fees Moody’s charged for structured C.D.O.’s were three times those for
conventional corporate debt, enabling the company to take in an
incredible $3 billion between 2002 and 2006. And since it had operating
margins above 50 percent on its rating work, most of this newfound El
Dorado was profit. When Moody’s stock soared, it increased the market
value of Buffett’s stake from $499 million, in 2001, to $3.2 billion, in
February 2007. The Oracle of Omaha thus made a $2.7 billion profit from
the very “time bombs” he was at the time publicly damning.

Moody’s ratings, meanwhile, enabled these derivatives to spread like
kudzu throughout the global financial pipelines—until the entire house
of cards collapsed in 2008. Moody’s then had to downgrade more than 90
percent of all asset-backed C.D.O. investments issued in 2006 and 2007,
and Buffett, alas, lost a good part of his windfall. It is hardly
conceivable that Buffett, who famously prides himself on the scrutiny he
gives to companies in which he invests, could not have known that the
heart of the Moody’s money machine was certifying hundreds of billions
of dollars worth of C.D.O.’s for purchase by banks and other
institution. If he didn’t know that, what kind of Oracle is he?

http://www.marketwatch.com/story/derivatives-are-the-new-ticking-time-bomb
Derivatives the new 'ticking bomb'
Buffett and Gross warn: $516 trillion bubble is a disaster waiting to happen

By Paul B. Farrell, MarketWatch

ARROYO GRANDE, Calif. (MarketWatch) -- "Charlie and I believe Berkshire
should be a fortress of financial strength" wrote Warren Buffett. That
was five years before the subprime-credit meltdown.

"We try to be alert to any sort of mega-catastrophe risk, and that
posture may make us unduly appreciative about the burgeoning quantities
of long-term derivatives contracts and the massive amount of
uncollateralized receivables that are growing alongside. In our view,
however, derivatives are financial weapons of mass destruction, carrying
dangers that, while now latent, are potentially lethal."
   	
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funds. Highlights:

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That warning was in Buffett's 2002 letter to Berkshire shareholders. He
saw a future that many others chose to ignore. The Iraq war build-up was
at a fever-pitch. The imagery of WMDs and a mushroom cloud fresh in his
mind.

Also fresh on Buffett's mind: His acquisition of General Re four years
earlier, about the time the Long-Term Capital Management hedge fund
almost killed the global monetary system. How? This is crucial: LTCM
nearly killed the system with a relatively small $5 billion trading
loss. Peanuts compared with the hundreds of billions of dollars of
subprime-credit write-offs now making Wall Street's big shots look like
amateurs.

Buffett tried to sell off Gen Re's derivatives group. No buyers.
Unwinding it was costly, but led to his warning that derivatives are a
"financial weapon of mass destruction." That was 2002.
Derivatives bubble explodes five times bigger in five years

Wall Street didn't listen to Buffett. Derivatives grew into a massive
bubble, from about $100 trillion to $516 trillion by 2007. The new
derivatives bubble was fueled by five key economic and political trends:

    1.

       Sarbanes-Oxley increased corporate disclosures and government
oversight
    2.

       Federal Reserve's cheap money policies created the
subprime-housing boom
    3.

       War budgets burdened the U.S. Treasury and future entitlements
programs
    4.

       Trade deficits with China and others destroyed the value of the
U.S. dollar
    5.

       Oil and commodity rich nations demanding equity payments rather
than debt

In short, despite Buffett's clear warnings, a massive new derivatives
bubble is driving the domestic and global economies, a bubble that
continues growing today parallel with the subprime-credit meltdown
triggering a bear-recession.

Data on the five-fold growth of derivatives to $516 trillion in five
years comes from the most recent survey by the Bank of International
Settlements, the world's clearinghouse for central banks in Basel,
Switzerland. The BIS is like the cashier's window at a racetrack or
casino, where you'd place a bet or cash in chips, except on a massive
scale: BIS is where the U.S. settles trade imbalances with Saudi Arabia
for all that oil we guzzle and gives China IOUs for the tainted drugs
and lead-based toys we buy.

To grasp how significant this five-fold bubble increase is, let's put
that $516 trillion in the context of some other domestic and
international monetary data:

     *

       U.S. annual gross domestic product is about $15 trillion
     *

       U.S. money supply is also about $15 trillion
     *

       Current proposed U.S. federal budget is $3 trillion
     *

       U.S. government's maximum legal debt is $9 trillion
     *

       U.S. mutual fund companies manage about $12 trillion
     *

       World's GDPs for all nations is approximately $50 trillion
     *

       Unfunded Social Security and Medicare benefits $50 trillion to
$65 trillion
     *

       Total value of the world's real estate is estimated at about $75
trillion
     *

       Total value of world's stock and bond markets is more than $100
trillion
     *

       BIS valuation of world's derivatives back in 2002 was about $100
trillion
     *

       BIS 2007 valuation of the world's derivatives is now a whopping
$516 trillion

Moreover, the folks at BIS tell me their estimate of $516 trillion only
includes "transactions in which a major private dealer (bank) is
involved on at least one side of the transaction," but doesn't include
private deals between two "non-reporting entities." They did, however,
add that their reporting central banks estimate that the coverage of the
survey is around 95% on average.

Also, keep in mind that while the $516 trillion "notional" value
(maximum in case of a meltdown) of the deals is a good measure of the
market's size, the 2007 BIS study notes that the $11 trillion "gross
market values provides a more accurate measure of the scale of financial
risk transfer taking place in derivatives markets."
Bubbles, domino effects and the 'bad 2%'

However, while that may be true as far as the parties to an individual
deal, there are broader risks to the world's economies. Remember back in
1998 when LTCM's little $5 billion loss nearly brought down the world's
banking system. That "domino effect" is now repeating many times over,
straining the world's monetary, economic and political system as the
subprime housing mess metastasizes, taking the U.S. stock market and the
world economy down with it.

This cascading "domino effect" was brilliantly described in "The $300
Trillion Time Bomb: If Buffett can't figure out derivatives, can
anybody?" published early last year in Portfolio magazine, a couple
months before the subprime meltdown. Columnist Jesse Eisinger's $300
trillion figure came from an earlier study of the derivatives market as
it was growing from $100 trillion to $516 trillion over five years.
Eisinger concluded:

"There's nothing intrinsically scary about derivatives, except when the
bad 2% blow up." Unfortunately, that "bad 2%" did blow up a few months
afterwards, even as Bernanke and Paulson were assuring America that the
subprime mess was "contained."

Bottom line: Little things leverage a heck of a big wallop. It only
takes a little spark from a "bad 2% deal" to ignite this $516 trillion
weapon of mass destruction. Think of this entire unregulated derivatives
market like an unsecured, unpredictable nuclear bomb in a Pakistan
stockpile. It's only a matter of time.
World's newest and biggest 'black market'

The fact is, derivatives have become the world's biggest "black market,"
exceeding the illicit traffic in stuff like arms, drugs, alcohol,
gambling, cigarettes, stolen art and pirated movies. Why? Because like
all black markets, derivatives are a perfect way of getting rich while
avoiding taxes and government regulations. And in today's slowdown, plus
a volatile global market, Wall Street knows derivatives remain a
lucrative business.

Recently Pimco's bond fund king Bill Gross said "What we are witnessing
is essentially the breakdown of our modern-day banking system, a complex
of leveraged lending so hard to understand that Federal Reserve Chairman
Ben Bernanke required a face-to-face refresher course from hedge fund
managers in mid-August." In short, not only Warren Buffett, but Bond
King Bill Gross, our Fed Chairman Ben Bernanke, the Treasury Secretary
Henry Paulson and the rest of America's leaders can't "figure out" the
world's $516 trillion derivatives.

Why? Gross says we are creating a new "shadow banking system."
Derivatives are now not just risk management tools. As Gross and others
see it, the real problem is that derivatives are now a new way of
creating money outside the normal central bank liquidity rules. How?
Because they're private contracts between two companies or institutions.

BIS is primarily a records-keeper, a toothless tiger that merely
collects data giving a legitimacy and false sense of security to this
chaotic "shadow banking system" that has become the world's biggest
"black market."

That's crucial, folks. Why? Because central banks require reserves like
stock brokers require margins, something backing up the transaction.
Derivatives don't. They're not "real money." They're paper promises
closer to "Monopoly" money than real U.S. dollars.

And it takes place outside normal business channels, out there in the
"free market." That's the wonderful world of derivatives, and it's
creating a massive bubble that could soon implode.

Comments? Yes, we want to hear your thoughts. Tell us what you think
about derivatives: as "financial weapons of mass destruction;" as a
"shadow banking system;" as a "black market;" as the next big bubble
dangerously exposing us to that unpredictable "bad 2%."

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