Warren Buffett is poised to issue his most doom-laden forecast for the state of the world economy yet, including a damning verdict on the derivatives industry he fears could cause a global financial crisis.
In the upcoming annual letter to shareholders of Berkshire Hathaway, Mr Buffett drops his usual folksy style to warn that banks do not understand the hidden risks lurking on their balance sheets....
...Until now vague warnings about the pyramid nature of derivatives contracts have led to bland assurance from banks that there is no threat to their stability.
Mr Buffett says the banks simply have no idea what their exposure could be. "When Charlie [Munger, his business partner] and I finish reading the long footnotes detailing the derivatives activities of major banks, the only thing we understand is that we don't understand how much risk the institution is taking."....
..."Reinsurance and derivatives businesses are similar. Like Hell, both are easy to enter and almost impossible to exit," he says.
Mr Buffett, dubbed the Sage of Omaha, believes that major insurers are exaggerating earnings from derivatives contracts and underplaying the "daisy chain risk" that comes when they lay off business with other firms....
This was written in March 2003. If he didn't have the instrument (Mortgage Backed Securities; CDO's) exactly right, he sure as hell nailed what happened to AIG, Bear, Citi, Fannie and Freddie et al.
This is why we post so much Buffettania on a blog ostensibly about climateering.
