Buffett breaks his rules -- again

Warren Buffett's apprehension toward derivative reform is interesting, given his past view of this slice of the market.

By TheStreet Staff Apr 30, 2010 9:39AM

Image credit: © Chip East/ReutersBy Don Dion, TheStreetTheStreet.com


Given Warren Buffett's knack for making money, it's no wonder that the ears of investors around the globe perk up when he opens his mouth -- but what Buffett says doesn't always coincide with what he does.


During recent months, Buffett has diverged from his teachings several times. 


At the end of 2009, Buffett expressed his disapproval for Kraft Foods' (KFT) stock-heavy bid for Cadbury. In the past, the investor had opposed deals that were funded using an excessive amount of company shares. His concerns stem from his belief that an influx of new stock dilutes the voting power of existing shareholders. Also, the injection of extra supply of stock puts pressure on share price, driving it lower.


This lesson was pushed by the wayside when Buffett decided to buy the remaining stake of Burlington Northern Santa Fe Railroad for $34 billion. Buffett not only used company stock to fund the largest deal in Berkshire Hathaway's (BRK.A) history, but at the start of 2010, he received shareholder approval for a 50-for-1 split on Berkshire Hathaway B shares (BRK.B).


More recently, the debate over financial reform has highlighted another situation in which Buffett blatantly diverges from his own rule book.


Right now, Buffett is opposed to Washington's proposed plan to reform the U.S. financial system. One particular area of concern for the Nebraska native is Congress' bold plan to regulate the derivative industry. As the proposed bill stands, companies will have to offer collateral for derivative contracts to protect against potential losses.


Fearing detrimental effects as a result of Congress' actions, Buffett has strongly urged Congress to include a provision to the bill that would exempt current derivatives from the proposed changes.



Buffett's apprehension toward derivative reform is interesting given his past view of this particular slice of the market. In Berkshire Hathaway's 2002 annual report, the Oracle of Omaha described derivatives as "time bombs" and "financial weapons of mass destruction."


This harsh rhetoric might lead one to assume that Buffett steers clear of these instruments. However, such an assumption would be incorrect. While many think Berkshire Hathaway's success stems solely from its successful investment portfolio, which includes household names such as Coca-Cola (KO), Wells Fargo (WFC) and Procter & Gamble (PG), Buffett's company has also expanded its purse by managing a massive derivative portfolio valued at $63 billion, some of which are used by MidAmerican Energy to hedge energy prices.


Given Buffett's sizable exposure to these "weapons of mass destruction," it is no surprise that Buffett is at odds with Washington over the proposed plan to regulate the way they are traded.


Buffett's No. 1 rule is "don't lose money." As shown over the past few months, sticking to this rule has sometimes required the financier to bend or break other rules. This should not dissuade individuals from turning to him for general investing wisdom. By following Buffett's advice, investors can construct a portfolio that provides returns that are stable over the long term. But when it comes to government policy, it raises the question of whether his words or his actions are the more important guide.


This weekend, Buffett will be in Omaha for the annual Berkshire Hathaway shareholder meeting. What do you think is the most important topic the financier should cover at this convention?


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