INVESTORS ARE betting that Berkshire Hathaway, Warren Buffett's investment vehicle, is in danger of defaulting on its debt and is more at risk than many financials decimated by multi-billion dollar write-downs, writes PROINSIAS O'MAHONY.
Berkshire's credit-default swaps (CDSs), which measure the risk of debt default, soared this week to all-time highs on increased speculation that Buffett may be undone by the derivative instruments he has so often railed against.
The cost of insuring $10 million (€8 million) in Berkshire bonds soared to $490,000, double last week's price and a five-fold increase since September.
That's markedly higher - as much as four times - than similar companies in the insurance world, and even higher than the biggest of the global banks, such as beleaguered Citigroup and Morgan Stanley.
Attracting particular attention in a fast-declining stock market has been Buffett's dabbling in index options. He disclosed last year that Berkshire had received $4.5 billion in premiums from investors hedging against the prospect of long-term market declines. The firm faces a crippling payout of up to $37 billion if, on specific dates beginning in 2019, particular indices are lower than they were on the day the contracts were written.
While many have commented on the irony of Buffett's utilisation of derivatives - he famously denounced them as "financial weapons of mass destruction" - his defenders dismiss the market's reaction as hysterical.
One fund manager and Berkshire shareholder said that CDS buyers were projecting "present circumstances into infinity", adding that a $37 billion loss "will never happen". Whitney Tilson, another large shareholder and hedge fund manager, dismissed the notion that there were "any hidden derivative bombs on Berkshire's balance sheet".
Tilson pointed out that the $37 billion figure was the "maximum payout if all four major world indices were at zero 14-19 years from now".
Others speculate that the spike in Berkshire swaps might hint at hidden troubles at the firm. Jeff Matthews, hedge fund manager, blogger and author of Pilgrimage to Warren Buffett's Omaha, an admiring 2008 book on Buffett, said that higher moves in the CDS market had been an "excellent early warning indicator" in countless other financial stocks. Why?
"Companies doing business with highly leveraged financials can buy credit default swaps in those financials in order to hedge the risk of a collapse," said Matthews, pointing out that Goldman Sachs had been buying swaps in AIG to hedge their counterparty risk "well before that firm hit the wall".
Berkshire's share price has almost halved since September and fell on nine consecutive days before arresting the slide in early trading yesterday. For the third quarter the company posted a 77 per cent decline in profits as a result of catastrophe insurance claims and falling equity markets.
However, Buffett is renowned for not fretting over short-term market movements, and is not likely to be losing sleep over accusations that he has taken on undue risk in his use of derivatives. Berkshire has "at least 60 derivatives", he told shareholders two years ago, "and believe me: we'll make money on all of them".
