Re: [Marxism] Key Obama backer worth $50 billion profits fromtaxpayer bailout of Wall Street

["Joaquin Bustelo" <jbustelo@xxxxxxxxx>]

Duane Roberts writes: "I should mention that another reason why Warren
Buffett came out strongly in favor of a taxpayer bailout of Wall Street has
to do with the fact he sold about $4.5 billion worth of 'puts' in
international financial markets shortly before the capitalist economy
started it's downward spiral.... [S]ome body made a $4.5 billion bet with
Buffett that stock indices will be lower in a couple of years.... If these
indices are below where they were when these 'puts' were bought, he has to
pay out about $40 billion when the expire."

The "puts" were sold in 2007 or before, and all we know about them is what
Buffett himself chose to disclose in his 2007 annual report. They are
insurance against four stock indexes being below the then-current levels
(when the contracts were signed) at the time the "puts" expire starting in
2019. One of the indices is the S&P 500, the other three weren't disclosed
but are foreign indices.

It is not true that if  "in a couple of years," the indices are below their
levels when the contracts were signed, Berkshire Hathaway will then owe $40
billion. 

That figure is said to be the company's MAXIMUM exposure, not what it owes
if the indices are down by .1% or 1% or 10%, but by 100%, in other words if
all four indices get completely wiped out, all of them go to zero, yet the
configuration of the world is such that Berkshire-Hathaway would *still*
have to pay, then it would owe that much. 

Also, the contracts expire between 2019 and 2027, i.e., not "in a couple of
years" but in a decade or two, and can be exercised only upon expiration.
The original terms were 15-20 years, which suggests that they pre-date the
2007 stock market peak although presented by Buffett in  such a way that one
gets the impression --though he doesn't actually say this-- that the deals
were done in 2007.

We do not know the exact contract terms, but assuming a linear relationship
down to the maximum level of exposure, if stock market indices remain where
they are today, roughly at 60% of 2007 levels, and assuming those 2007
maximums are the levels the contracts specify, Berkshire-Hathaway faces an
exposure of up to $16 billion.

The question is, how much is Berkshire-Hathaway likely to make from the $4.5
billion premium *before* it has to pay on the contracts? 

Berkshire-Hathaway's yearly after-tax returns over 40 plus years have
averaged more than 21%, and for the last 10 years included in the most
recent annual report, 12.6%. (Buffett says the company's size now precludes
the outsized 20%+ yearly gains of earlier decades).

Assuming for simplicity's sake a 17.5 year holding period for the entire 4.5
billion in premiums (the average of the 15-20 year contract term Buffett
disclosed), and the 12.6% rate of return, by the end, Berkshire-Hathaway's
stash would have grown to $39.4 billion. 

At 10% --the long terms average return of the US stock market-- the premiums
and returns would add up to $25 billion. 

Even at a miserable return of 5%, Buffett would have more than $10 billion
on hand to cover payments -- if any.

On the other side, assuming that from current levels the stock market
indices merely keep up with the historical average of a 3% annual inflation
rate, in 2023 [the average expiration date] stocks would be about 12% below
typical 2007 levels, making Berkshire Hathaway's exposure less than $5
billion. But if the contracts were actually signed a year or two earlier
(2005-2006), even that loss disappears.

And if the stock market price levels produce a NET return after inflation of
1% --and not even taking into account one cent in dividends-- Buffett's
exposure would be zero even if the contracts had been signed at the very
peak of the market.

Obviously Warren Buffett is a capitalist, a very large capitalist. If
capitalism does well, he does well. He WANTS the capitalist economy to grow
and prosper for that simple reason. But to suggest that he was pimping for
the rescue package because of the configuration of his own immediate
interests and liabilities in this case is simply not true. It is way too far
in the future for that, and there are too many other variables and unknowns.

An expert in financial markets that I know from my day job explains this
deal very differently. 

These are *very* long-term contracts (as these things go) meant to "lock in"
stock market levels at what was probably seen as the peak of a cyclical
upswing or even a bubble, but more importantly, price levels that are high
enough to cover certain obligations that are due far in the future payable
by the firms that dealt with Buffett.

Formally, these contracts protect against the danger of a ruinous long-term
decline in the market (ruinous for a pension fund or an insurance company
with annuity-type obligations). 

But the more important thing they do is to protect those sorts of firms from
having to recognize huge but probably only temporary stock market losses on
assets being held to pay obligations far in the future. Otherwise these
firms might have been forced into bankruptcy by accounting rules, or at any
rate suffered credit downgrades, so they'd have to pay higher interest
rates, etc. 

Thus Berkshire's insuring them against low stock market levels a long time
from now is worth a lot to certain types of firms TODAY, because the REAL
risk that is being eliminated is being forced to take huge paper losses due
to a big stock market downturn, as in fact actually happened, and which,
under current accounting rules, would have seriously damaged or wiped out
those firms if they had not bought this insurance.

The reason it works is that the obligation that Berkshire-Hathaway assumes
is NOT to pay for a shortfall in these company's equity RIGHT NOW, when the
stock market has taken a dive, but simply to make up for any shortfall in
the price of stocks many, many years in the future, which means that the
firms that bought the insurance do not have to recognize the stock market
dive now because they are guaranteed a much higher minimum price for their
stocks in 10, 15 or 20 years and they finally have to sell those stocks.
That because Bekrshire Hathaway promises to make up the shortfall and has
the resources to do so.

Almost certainly, this will not happen, and even if it does, Berkshire
Hathaway will have made enough money from investing the premiums to cover
the risk. What Buffett is betting is that the economy will generally right
itself and will grow at least minimally over a 15-20 years period.

And notice how much of *its own* capital Berkshire-Hathaway has tied up in
this deal: $0. 

One downside for Berkshire Hathaway are huge *paper* losses at times like
now. In effect, Buffett is being paid for taking the paper losses of OTHER
firms due to the current stock market meltdown and listing those paper
losses on HIS balance sheet instead. 

But being purely short- or medium-term paper losses, if capitalism survives
at all, Buffett is almost certainly going to be vindicated for saying he's
not going to pay any attention to them because by the time his obligations
come due, stock market prices will be higher or he will have had a chance to
"lock in" higher prices through future contracts during a cyclical market
upswing.

Now if the economy continues to nosedive and the stock market to tank for
many years, almost certainly even Buffett won't be making much money and
this deal may well turn out to be devastating. But realistically, the social
and political consequences of such a prolonged capitalist crisis will
outweigh the merely financial impact. 

In other words, if capitalism CAN'T recover it likely won't still be around
by the time Buffett's obligations come due. 

An incredible number of stupidities have been written by financial
journalists about this deal. For example, that Buffett has gotten into the
same speculative derivatives trade that sunk AIG and so many others. That
Buffett has "lost" many billions of dollars (losses that in reality exist
only on paper). The New York Post has even been claiming that
Berkshire-Hathaway faces an immediate liquidity crunch because it has to
hoard cash to meet these obligations. The potted plants that write financial
news for Murdoch apparently can't tell the difference between 2019 and 2009.
And although these are derivatives, these are not the credit default swaps
and other derivatives that torpedoed the U.S. financial system, nor is
Buffett getting into the business of trading these sorts of obligations.
Despite the form, they are, in essence, an insurance "product," which has
been Buffett's major business from the outset.

At any rate, we should not add to the confusion with loose writing about
this sort of deal. There are plenty of absolutely catastrophic and
outrageous things going on without stretching the truth about a deal like
this.

A very interesting side discussion around this is Buffett's contention that
stock options are mispriced, and the longer the period involved the greater
the discrepancy. But that is a discussion for another time and probably a
different forum.

Joaquin


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