Warren Buffett's derivative drama

Financial reform proposals could hurt Berkshire Hathaway, so the company is lobbying hard on derivatives.

By Kim Peterson Apr 26, 2010 2:27PM
Credit: (© Paul WhiteRemember how Warren Buffett called derivatives "financial weapons of mass destruction" that could ruin the entire economic system?

Well, it turns out that Buffett's Berkshire Hathaway (BRK.B) has a $63 billion derivatives portfolio, according to The Wall Street Journal. And Buffett has been lobbying Capitol Hill to protect that portfolio by exempting it from new rules in the financial reform proposals.

Since his "weapons of mass destruction" comments, Buffett has backtracked a little to make his position clear. Yeah, derivatives can be dangerous, but he still uses them. You just have to be careful.

Buffett has a lot at stake here. And so he's pretty antsy about a proposed change that would require companies like Berkshire to put aside oodles of money to cover potential derivatives losses, the Journal reports.

Buffett doesn't want to set aside the collateral, and wants existing derivatives contracts to be exempted from the rules. Berkshire doesn't want to redo its contracts, the Journal reported, and is arguing that it has the money to cover problems if necessary. Post continues after video:
Berkshire surely does, but what about other companies playing in derivatives? The White House reportedly is against Berkshire on this one, saying that it would hurt the government's ability to regulate the derivatives market.

It's always tricky to explain derivatives, but the Journal does it well by calling them "bets between two parties on the future price of a good." They help companies hedge against risk.

Southwest Airlines (LUV), for example, uses derivatives for about 65% of its fuel consumption this year. Derivatives help the airline stabilize its fuel prices. Would Southwest have to set aside money to cover its derivative bets? It looks that way from the legislation.
Berkshire is arguing that hundreds of companies that legitimately use derivatives would be hurt under the proposal. Ironically, the companies that could benefit from this are the Wall Street firms that Congressional Democrats are trying to keep in check, Berkshire says, according to the Journal.

That's because if companies like Berkshire have to put their own collateral down, then Wall Street firms won't have to buy as much insurance for possible defaults.
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