I’m not so sure I believe the wild speculation part of this (last para), but I know Jon Markman, and he is a thoughtful and sober guy.

He writes:

Shares of Warren Buffett’s insurance holding company are on the ropes this month, plunging 30% in part because the famed investor dabbled in an area of the market he has long publicly derided: derivatives. And due to a tangled web of financial relationships, they may be taking Goldman Sachs shares down with them.

Investors are concerned about a $37-billion bet that Buffett made last year that U.S. and world equity values would be higher in 15 to 20 years than they were then, when the Dow Jones Industrials were trading around 13,000. Through his firm, Berkshire Hathaway, Buffett sold option contracts, known as “naked puts” to an undisclosed group of investors for around $4.85 billion, reportedly using Goldman as broker.

The buyers saw the puts as a type of insurance that would pay off royally if stocks fell over the next decade. They were seen by Buffett as an easy way to pocket a quick $4 billion-plus, which was booked much like an insurance premium, even though he is famous for scoffing at derivatives as “weapons of mass financial destruction.”

But easy money is the worst kind. The problem is that stocks worldwide have gone downhill in a hurry, and with a lot of the sort of volatility that makes put contracts swell in value. And due to accounting rules, this has made Buffett already need to mark down a $6.7 billion loss on the trade even though the trade has another 14 years to work out.

Because of its solid-gold credit rating, Berkshire Hathaway was not required to put up collateral to make this trade. But now rumors are flying on Wall Street that the owners of the contracts have demanded that broker Goldman Sachs put up collateral for the rest of the amount due. Since the value of the trade could be enormous, the collateral demands are said to be very large, and fears that Goldman will struggle to make good on its obligation has panicked shareholders.

Indeed one theory making the rounds this week is that Buffett put $5 billion into Goldman at around $125 per share in September not as an investment but to help provide funds for the collateral.

It is interesting nonetheless . .


Buffett’s huge derivatives bet proves costly
Jon Markman
MSN, Nov 20 2008, 12:48 PM


Category: Derivatives, Markets, Options, Valuation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

20 Responses to “Jon Markman: Buffett in Trouble?”

  1. Vermont Trader says:

    Insurance companies write puts. That is what insurance is..

    I am struggling to come up with any reason why GS as broker would have to put up collateral for puts written by BRK.A… This seems to be the main point of the article and there is no reasoning to back it up…

    This article is useless.

  2. Archiphage says:

    I wonder what the exercise provisions are on these puts. Also, I think the ‘financial WMD’ quote refers to OTC interest rate and currency swaps and such… not so much equity and equity index options. Anyway, who are these bozos fading Warren? Obviously they didn’t think things through when they entered this transaction. ‘Oooh… let’s buy fire insurance from the guy who’s sole asset is the wooden building next door!’ Now they’re demanding collateral? Was such a provision in the contract, or are they just making this up as they go along? Looking around the landscape these days, I’d bet on the latter.

  3. Patrick Neid says:

    Bets from the grave! Buffett’s own actuary tables say he probably won’t be around to see if he’s right.

    Now that’s what I call a banger!

  4. Vermont Trader says:

    Speaking of Buffet, I just saw a robin, which shouldn’t be anywhere near here on a 10 degree morning in VT…

    Brave little bird.. doesn’t he know that spring isn’t for months.

  5. ericholtman says:

    I wonder what the exercise provisions are on these puts.

    I’m fairly certain they were European……

    yup…. http://www.berkshirehathaway.com/letters/2007ltr.pdf, page 16:

    “The second category of contracts involves various put options we have sold on four stock indices
    (the S&P 500 plus three foreign indices). These puts had original terms of either 15 or 20 years and were
    struck at the market. We have received premiums of $4.5 billion, and we recorded a liability at yearend of
    $4.6 billion. The puts in these contracts are exercisable only at their expiration dates, which occur between
    2019 and 2027, and Berkshire will then need to make a payment only if the index in question is quoted at a
    level below that existing on the day that the put was written.”

  6. Archiphage says:

    European was really the only way that made sense of the rest of it. Otherwise we’d be reading about how Buffett just had a crapload of stock put to him.

  7. Well, I’m ready for a market melt-up.

  8. jakester says:

    The constant praise of the “Oracle” brought about right at the DOW top. The star always signs the brightest just before it dies..

  9. bonghiteric says:

    BRK’s historical return on equity has been around 10%, lets say it takes a hit in the next 14 years, maybe it decreases to 7% or 8%. I’d take $4.5B for 14 years at that return. A pretty steely low cost use of funds with terms he’d never see if it wasn’t for all the market turmoil. Besides if it blows up in 14 years A.) there will be a lot bigger problems to deal with B.) Ajit will have to clean up the mess, the oracle will be resting comfortably.

  10. jrhyno says:

    So, big rinse today? Big washout? Or do we scream up in the afternoon? Any thoughts?

  11. I-Man says:


    I dont dispute the trade… only the authors interpretation of it.

    I’ve heard the Oracle say pubicly before that he is intimately aware of and involved in the management of every single derivative contract that is on the books of Berkshire. Every one. And further, given the nature of the exercise of those puts… looks like a damn smart trade to me. All derivatives, and securities involve risk. Coming from a dude whose had more years of experience taking risk successfully when others were afraid to do so than most of us have been alive, I’d be willing to bet my stake that he’s comfortable with the level of risk taken. The Goldman part is speculation at best though… why would GS have to put up collateral for a BRK trade? Doesnt make any sense. And how could the 25 bill of “Perpetual Preferreds” be looked at as collateral? Also doesnt make any sense, unless its some kind of financial wizardry I’m not aware of… which is certainly possible in this day and age of investment banks turning bank holding companies, etc.

    I actually think the BNI puts are going to pay off nicely for the old chap… in either scenario. You think he wouldnt mind owning some more BNI below 70!? Come on. Its a win/win if you believe in the long term cash flows of the company. Claims on that long term stream are still uber viable.

    Full Disclosure: I do own shares of BNI.

  12. I-Man says:

    Ok… Ok… BR we REALLY need a preview.

    Buffet hasnt said anything “Pubicly” to me… and I hope he never does.

    I meant to say:

    “I’ve heard the Oracle say PUBICLY…”

    But it was worth the laugh.

  13. I-Man says:

    Ok.. I dont know how to type PUBLICLY. I give up. Capitulation. Need coffee. Fast.

  14. Vega says:

    Vermont Trader you are correct, GS does not have to put up collateral for the losses on Warren’s put sales. Rather, the market is pissed that BRK/A does not have to post collateral to GS for the puts GS bot from BRK/A. In fact, Buffett started selling these puts in 2005 to GS, DB, and MER. Don’t know if any other firms were involved. Each of the three I mention probably bot about 75 million vega from Buffett, at least, so these were and still are huge trades.

    The puts are definitely Euro-style. So, since they cannot be exercised until maturity they will NEVER trade for parity (spot minus strike) until experiation. Rather, they’ll trade for the PV of parity until expiration, plus the vol value of the same-strike calls. There is a LOT of vol value to these puts/calls. Why? They still have 13.5 years till they mature.

    One way of looking at Buffett’s put sales is to consider them, from his perspective, as FREE LOANS. He posts ZERO collateral on them, and he collects the premium up-front. And, he only has to pay up if they expire ITM.

    I don’t know. It kinda bugs me he sold these puts, especially after his whole “derivs are a disaster” talk. It also bothers me that he did ZERO due diligence on his GS purchase. That boggles my mind. He spends years winding down GenRe’s derivs posy and in the span of an afternoon decides to invest billions with Blankfein & Co. based solely on GS’s rep. That’s a shitty decision process. Works well when you buy simple businesses. But GS is not simple, and neither were GenRe and Solly. We’ll see.

  15. Al Czervik says:

    This would fit into one of Kass’ annual “surprises” column. Not necessarily a prediction but something that *could* happen. In a world that’s upside-down, one cannot assume that even Warren Buffet is immune.

    I would speculate that problems at BRK would shake the public and the markets much more severely than some of the commercial banks and investment banks that have had problems.

  16. MarkC says:

    Here’s a contra thesis to the Markman article – and this one does more meaningful quantitative analysis:

    Berkshire Hathaway Credit Risk, Index Puts Are Overblown Worries


    BR: Terrible Call — Berkshire Hathaway collapsed 35% since then

  17. MorticiaA says:


    I’m brand new here. There are precious few opportunities to ROFL these days…. Thank you, sincerely.

  18. jrhyno says:

    So, looks like we are going down, yea or nay? Another headfake this morning, perhaps with the double Minsk Pinsk later this afternoon!

  19. The Curmudgeon says:

    It’s pretty fantastic to imagine that Berkshire Hathaway’s stock has declined 30% or more on the basis of some puts that don’t pay out, if ever, for fourteen more years.

    Berkshire’s stock is declining for a reason, but not this one. Think of something else. Perhaps it has something to do w/ Goldman, but it wouldn’t be this.

  20. jakester says:

    ahhh.. so GS brokered his trade ehh.. likely they are sitting on the other side of it then..