I must confess...I never knew these things about Berkshire Hathaway.
It seems Berkshire Hathaway is a big player in the CDS market.
I downloaded Berkshire Hathaway's annual report and went through it.
The company had booked a derivatives
MTM losses totalling $7.4 billion in 2008.
The company has two exposure in two major segments - puts of stock indices and CDS of individual companies and municipalities.
The total exposure to index puts is stated as $37.1 billion. That is the amount that the company would lose if all indices would go to 0.
(The company has exposures to S&P 500, FTSE 100, Euro Stoxx 50 and Nikkei 225 puts).
These puts are mostly long-term and are exercisable between 2019 and 2028. That's a long time. My guess is the indices would bounce-back in next few years and wipe-off the MTM losses.
========================================
The CDS part is what is worrying some investors.
I am quoting directly from the 2008 annual report of Berkshire Hathaway.
Quote:
The second category we described in last year’s report concerns derivatives requiring us to pay
when credit losses occur at companies that are included in various high-yield indices. Our standard
contract covers a five-year period and involves 100 companies. We modestly expanded our position
last year in this category. But, of course, the contracts on the books at the end of 2007 moved one
year closer to their maturity. Overall, our contracts now have an average life of 2.33
years, with the first expiration due to occur on September 20, 2009 and the last on December 20, 2013.
By year-end we had received premiums of $3.4 billion on these contracts and paid losses of $542
million. Using mark-to-market principles, we also set up a liability for future losses that at year-end
totaled $3.0 billion. Thus we had to that point recorded a loss of about $100 million, derived from
our $3.5 billion total in paid and estimated future losses minus the $3.4 billion of premiums we
received. In our quarterly reports, however, the amount of gain or loss has swung wildly from a
profit of $327 million in the second quarter of 2008 to a loss of $693 million in the fourth quarter of
2008.
Surprisingly, we made payments on these contracts of only $97 million last year, far below the
estimate I used when I decided to enter into them. This year, however, losses have accelerated
sharply with the mushrooming of large bankruptcies. In last year’s letter, I told you I expected these
contracts to show a profit at expiration. Now, with the recession deepening at a rapid rate, the
possibility of an eventual loss has increased. Whatever the result, I will keep you posted.
In 2008 we began to write “credit default swaps” on individual companies.
If, say, the XYZ company goes bankrupt, and we have written a $100 million contract, we are
obligated to pay an amount that reflects the shrinkage in value of a comparable amount of XYZ’s
debt. (If, for example, the company’s bonds are selling for 30 after default, we would owe $70
million.) For the typical contract, we receive quarterly payments for five years, after which our
insurance expires.
At year-end we had written $4 billion of contracts covering 42 corporations, for which we receive
annual premiums of $93 million. This is the only derivatives business we write that has any
counterparty risk; the party that buys the contract from us must be good for the quarterly premiums
it will owe us over the five years. We are unlikely to expand this business to any extent because
most buyers of this protection now insist that the seller post collateral, and we will not enter into
such an arrangement.
|
Note the 3 numbers that I have highlighted in red.
For CDS's (individual companies) of notional value $4 billion, the company had received a premium of $93 million.
What must be the total notional value of the initially-mentioned CDS's of "companies that are included in various high-yield indices",
if the premium received is as large as $3.4 billion...
?
========================================
This explains the anxiety that markets have:
Quote:
|
But there's a problem, of course. If you thought banks and hedge funds got highly leveraged, just wait until you look at insurance companies, whose claims-paying abilities are a minuscule fraction of their total potential claims. If municipalities for some reason started behaving a bit like the housing market and all defaulted at once, no monoline, not even Berkshire Hathaway, could come up with the money it needed.
|
Source.
After all, it was these CDS's that destroyed AIG.
Credit Default Swaps
Linear Mode
