May 2, 2010 8:06 pm

Buffett warns on derivatives legislation

Warren Buffett has stepped up his warnings over the impact of any move by the US Congress to bring in retroactive rules on the use of derivatives contracts.

The Berkshire Hathaway chief executive reassured a crowd of 37,000 at the investment vehicle’s annual meeting at the weekend that the plans would not cost the company “a dime”.

But he said that counterparties to Berkshire’s portfolio of derivatives deals would face increased costs if Congress required companies to hold reserves against existing contracts. Berkshire has a potential exposure of about $63bn (€47bn) to its derivatives portfolio.

Mr Buffett said the company would comply with any laws but would push for extra premiums, possibly as much as $1bn, from its counterparties to compensate for the additional cost. The counterparties include Goldman Sachs and Lehman Brothers.

He likened it to the difference between selling a furnished or unfurnished apartment. There was no problem supplying the couches and chairs, but the rental price would have to be brought into line to reflect the extra costs. “There was one price for collateralised and another for uncollateralised derivatives,” he said.

Congress is debating legislation on derivatives as part of efforts to reform the financial system and the products that helped bring it to the brink of collapse. Berkshire has lobbied heavily against the most sweeping proposals which would force companies to hold collateral against all outstanding derivatives contracts.

In comments to reporters on Sunday, Charlie Munger, Mr Buffet’s long time business partner, said that the regulators, not the bankers, were to blame for the financial crisis for because they did not control the banks properly.

 “When the tiger gets out and starts creating a lot of damage it is insane to blame the tiger,” Mr Munger said. “It is that idiot tiger keeper that … caused the problem and our solution is not to just beat the tiger but efforts to improve the tiger keeper.”

Berkshire has a complex relationship with derivatives. In the past Mr Buffett has been a strong critic, famously calling them “weapons of financial mass destruction”.

However, Berkshire has built a sizeable derivatives portfolio over the past two years. By the end of 2009 it had made bets on the future level of stock markets and agreed to insure municipal bonds, high yield credits and corporate debt against default.

Mr Buffett has defended the deals, saying they require almost no collateral and the counterparties have paid $6bn in premiums in advance – essentially providing him with a cheap way to borrow money over long periods.

However, should the Congress tussle over regulations on derivatives go against Mr Buffett, Berkshire could have to set aside up to $8bn to protect its derivatives portfolio, according to Barclays analysts. That would tie up capital that could otherwise be available to invest in profitable ventures.

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