OTC Derivatives and the "Buffett Amendment" (Update 1)

rc whalen's picture

There is a lot of news this week on financials coming from Washington and the noise level is drowning out some of the detail.  So when I heard that Berkshire Hathaway (BRK) CEO Warren Buffett was trying to slip an exception into the substitute legislation offered by Senator Blanche Lincoln (D-AK) to give his OTC derivatives book special treatment, I put aside my book project and picked up the short sword. 

The "Buffett Amendment" would have exempted all of the existing OTC derivatives contracts from the new collateral requirements in the financial reform legislation.  The fact that such a ruse was even necessary illustrates why we need to drive a wooden stake through the heart of OTC securities and derivatives, namely that some of the biggest corporates in the world are allowed to play at the roulette table without buying chips.  The "AAA" rated BRK, Caterpillar (CAT) and the other big corporates can trade OTC without posting any collateral or initial margin. 

What's wrong with this picture?

When you trade on a derivatives exchange, all of the customers must post margin.  It does not matter whether you are Warren Buffett or Lloyd Blankfein or Joe Sixpack, you must "show us the money."  But apparently Warren Buffett, the man who once called OTC derivatives "weapons of mass destruction," now needs to supplement BRK earnings by trading OTC derivatives without any collateral backing up the trades.  Hmm.

Now we know why BRK, CAT and the other big corporate came oozing out of the woodwork last year to defend the OTC derivatives market.  JPMorgan (JPM), Goldman Sachs (GS) and the other OTC dealers let Warren Buffett and the other "AAA" corporates play at the roulette table w/o any chips.  Wouldn't you like to be able to sit at the big table and play poker alongside Mr. Buffett w/o actually putting up any cash to back your bets? 

The best part of all is that Mr. Buffett called upon US Senator Ben Nelson (D-NE) to create a derivatives loophole that would benefit his company to the
tune of billions, a proposal Senate Democrats quickly quashed. Nelson was the insurance commissioner of NE prior to coming to Washington, so you could say that Nelson is a "previously owned" Republican.  It is my impression from speaking to members of both parties in Congress that Nelson is viewed as a complete idiot by his peers in the Senate.  Maybe the Sage of Omaha needs to find a new boy to carry his dirty laundry.  Do you think?

In any event, keep an eye on Mr. Buffett and the gang who populate the BRK CSUITE.  Despite their protestation of being conservative, "fundamental value" investors, it seem that Buffett and Co. are no different from the OTC derivatives dealer banks which enable his derivatives speculation.

And in case you find this opinion a little harsh, just remember that Mr. Buffett and his colleagues at BRK are the same folks who have been sanctioned by the SEC on several occasions for aiding and abetting the manipulation of corporate earnings using side letters and other canards taken from the insurance markets.  The use of side letters in the case of American International Group (AIG) to falsify corporate financial statements is the functional equivalent of using OTC derivatives sans collateral or initial margin to goose BRK earnings.  Do we see a pattern forming perhaps? 

But of course the Big Media is probably going to ignore this story tomorrow.  Other than a mention on WSJ (Damian Paletta who broke the story), CNBC earlier today (kudos to Michelle Caruso-Cabrera for enjoying the moment so) and MarketPlace radio, there has been virtually no press coverage of the Buffett Amendment.

I am attaching the revised OTC derivatives amendment that Chris Dodd (D-CT) and Senator Lincoln hope to put into the financial reform bill this week. One of these days I will tell you how Chris Dodd worked his way through "high" school.  Is this a great country or what?

Be well -- Chris