Apocalypse is nigh, Buffett tells Berkshire faithful
By Simon English in New York
[Telegraph, UK, 4 March]:
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.
He labels derivatives "time bombs, both for the parties that deal in them and the economic system" and "financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal".
The views of the world's second richest man are closely watched and his apocalyptic vision will do little to steady nerves on Wall Street or in the City of London. Extracts from his annual letter, to be delivered on Saturday but posted on Fortune.com yesterday, reveal that he has little optimism for the stock market.
"Despite three years of falling prices which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us. That dismal fact is testimony to the insanity of the valuations reached during the Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge," he writes.
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."
Derivatives are often complex financial instruments that allow investors to take bets on anything from share prices to the weather. Their range is limited, says Mr Buffett, "only by the imagination of man, or sometimes, so it seems, madmen". Enron was especially fond of derivatives, offering contracts that would be settled years in the future and claiming profits immediately.
Berkshire Hathaway acquired a derivatives dealer when it bought reinsurer Gen Re. After failing to sell this business, Mr Buffett is now closing it down though he admits this will take years. "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.
His personal fortune fell last year by $5 billion to $30 billion, leaving him second to Bill Gates in the rich