Wednesday, March 4, 2009 2 comments ++[ CLICK TO COMMENT ]++

Market betting against Berkshire Hathaway

Either the CDS (credit default swap) market is a gambling den or the market has clearly placed a bet against Berkshire Hathaway. Bloomberg reports that CDS on Berkshire is trading at levels more suited to junk-rated companies:

The cost of protecting against default by Warren Buffett’s Berkshire Hathaway Inc. soared to record levels more typical of junk-rated companies amid concern the firm faces losses on derivatives.

Credit-default swaps used to guard against losses on Berkshire’s debt climbed 15 basis points to 515 basis points at 3:45 p.m. in New York, according to CMA DataVision, and earlier reached 535. The contracts yesterday traded as if the company, rated Aaa by Moody’s Investors Service, was 11 grades lower at Ba2, according data from Moody’s capital markets research group.

The price may be rising on concern the Omaha, Nebraska- based firm will lose bets on the direction of world equity markets, high-yield corporate bonds and municipal debt. That scenario assumes Berkshire would drain its $25.5 billion cash hoard and then find itself unable to raise more from stock or bond sales or the company’s historically profitable insurance and utility businesses.

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The price of Berkshire’s credit-default swaps put it on par with buying protection on American Express Co., the biggest U.S. credit-card company by purchases, which are trading at 543 basis points.

Berkshire swaps still are about half the 1,102 basis points for protection on American International Group Inc., the insurer that this week recorded the largest quarterly loss in U.S. corporate history. And investors are demanding the equivalent of 948 basis points to protect the bonds of the Aaa-rated finance arm of General Electric Co.


There are various theories on who is buying the CDS contracts:

A total of 2,400 credit-default swaps protecting a net $4.4 billion of Berkshire debt from default were outstanding as of Feb. 27, according to the Depository Trust & Clearing Corp., which runs a central registry for the market.

“It could very well be that the insurance company or whoever it is who bought the derivatives are now buying the CDS to make sure they get paid,” Matthews said. “It’s a lot like a stock price, where it’s hard to know what makes it go up or down.”


Like most amateurs, I have no access to the CDS market and only know of some cursory information. It is not clear if a $4.4 billion (notional) bet would be considered illiquid and insignifant or not. It is also possible that some of the buyers are putting on the infamous chaos trade, which some speculate is also why parties are willing to buy CDS on US government debt--a remote scenario.

I don't follow Berkshire closely and don't understand derivatives very well, but I am confident that Buffett's put selling on major indexes will be profitable in the end. However, I am not confident with the rest of the derivatives contracts: payment obligations and CDS contracts written against selected businesses (there are 142 companies in total.) Since Berkshire is writing contracts as an insurer would (i.e. no hedging,) losses can be lethal. A lot of what one may have perceived as high quality and safe, such as AIG or G.E., have been brought to their knees. The Bush administration, as well as the present Obama administration, are very soft on some of these distressed firms but if Obama ever gets tough--say the citizens become unhappy--it is possible for these firms to literally collapse without government support. Having said that, I think the economy has seen the worst and, although unemployment, corporate profitability, and such, will be weak for an year or two, things should stabilize.

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2 Response to Market betting against Berkshire Hathaway

WideMoat
March 5, 2009 at 11:28 PM

The implications of this just about blow my mind (dramatic, I know).s Berkshire is one of the few AAA companies out there, a major insurer, reinsurer, and bond insurer.s If we think about the seller of the CDS as an insurer in the event of Berkshire's default, who REALLY would be able to pay?s I mean, if Berkshire is in trouble, with their risk management and balance sheet, it's hard to imagine some hedge fund being able to pay.

Sivaram
March 6, 2009 at 10:36 AM

Yeah, I'm not sure who is buying. But then again there are some crazy scenarios that people are betting against. I mean, we even have some buying CDS on US Treasuries. If the US government defaults, well...

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