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Commentary

Buffett – Down but Not Out?

Buffett’s saga continues. The shares of BRK-A were down, at the bottom a couple days back, to nearly 50% of their highs of $150K.

His derivatives bet (Buffett Crosses Over To The Other Side) has come back to haunt him. Berkshire Hathaway’s profits fell 77% in the last quarter, on lower income. That was a given, since he’s exposed largely to housing (interiors, pre-fab), consumer excess spending (netjets) and finance (Moodys, Amex).

But the biggest problem in the income,not yet truly recognised, is the $37 billion derivative bet. Buffett, as most of us know, wrote puts on the S&P and other indices, with an exposure of $37 billion, last November. He got $4 bn in premiums. These are about 40% down today, and the net loss, marked to market, is $14 bn I would imagine.

Buffett doesn’t have to put any collateral (or mark-to-market margin) because he’s rated AAA. Even if downgraded, Buffett won’t have to put up too much collateral:

A credit rating downgrade would likely not be material. Berkshire would have to post “nominal” additional collateral on derivatives of “far below 1 percent of assets” if Berkshire lost its “triple-A” ratings, Buffett’s assistant, Jackie Wilson, said. It was posting no such collateral as of Sept 30, when Berkshire assets totaled $281.7 billion.

A theory doing the rounds (round one and two) is that people who bought the puts are spooked that Berkshire is now a credit risk. One says that ah, even if the rating goes down, Mr. Buffett gets away with very little collateral. This therefore is driving up the cost of Berkshire CDS – insurance in case of a Berkshire default – to nearly 5%, of 500 basis points.

Another says that Buffett’s $5bn Goldman investment was primarily a way to provide extra collateral through the broker of these puts; I doubt that, since that would be too sweet a deal. (equity and collateral? Uhem)

Buffett himself believes US unemployment will go higher than 8%. (My personal belief is that it could go to 15%, totally random, number picking from free air) In that case, all the negative news will drive the stock lower, CDS higher, and in general create collateral needs out of nowhere.

Is this kind of fear unjustified? Is Buffett truly untouchable – and therefore, people are being idiots? Market prices are irrational a lot of the time, and unreasonably low in bad times. Yet, in a market that is driven by trust, we are seeing a serious lack of trust. And that has taken businesses down – Bear and Lehman – for good reason, that they were overexposed, and the revelation brought them down. Buffett is exposed, much more than is usually comfortable, and the news is likely to take the stock value much lower.

It may not go to zero though – there is enough cash on their balance sheet to cover the damage, and even if the S&P halves from here, they have enough assets to pay back the whole exposure by selling them (and will leave money behind). But we are not a rational market, and we will underpay. I doubt this is the end – watch for another 50-60% drop, more bad news, more revelations. (The SEC has asked for info. People will be watching like hawks)

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