Posted by Karl Denninger
WASHINGTON—Democrats took a step toward their goal of overhauling financial regulation, reaching a tentative deal to set restrictions on trading in exotic financial instruments known as derivatives.
Among the considerations still in the balance: A big provision being sought by Warren Buffett in recent weeks. A key Senate committee had changed its proposed overhaul of derivatives regulation after lobbying by Mr. Buffett’s Berkshire Hathaway Inc., potentially helping the famed investor avoid a financial hit, congressional aides say.
I thought these were weapons of financial mass destruction Warren?
What’s the problem? You don’t want to be forced to recognize the economic and accounting reality of your transactions? I don’t see why that should be a problem.
Posting margin on underwater positions is a reality for everyone who trades on margin – and you do a lot of it. There’s no reason why anyone – you included – should not have to put forward margin – in cash – just like everyone else.
Yeah, I know, Berkshire is “Strong”. So what? That’s not material to the point at hand, which is that when you are short a “PUT”, which is effectively what you are, and the position is underwater, you should be required to post margin!
Reliance on “future economic strength” to avoid this requirement is a big part of why the system nearly blew up. You were a part of it writing those contracts, and you now want to be exempted from safety and soundness requirements on something you identified – in public – as a dangerous practice.
Sorry, but no.
The provision, sought by Berkshire and pushed by Nebraska Sen. Ben Nelson in the Senate Agriculture Committee, would largely exempt existing derivatives contracts from the proposed rules. Previously, the legislation could have allowed regulators to require that companies such as Nebraska-based Berkshire put aside large sums to cover potential losses. The change thus would aid Berkshire, which has a $63 billion derivatives portfolio, according to Barclays Capital.
Why should you be exempt on an underwater position? This is a cash margin deposit and secures your performance. As the position comes back into the money (if it does) for Berkshire the margin requirements would disappear.
Of course if you’re wrong and the contracts do not come back into the money, then your margin becomes a realized loss.
That’s the real problem that is being addressed here – the possibility that these “margin deposits” become not speculative but rather realized losses. Berkshire could avoid this by declaring bankruptcy if it was to run into trouble in the future sticking the holder of these PUTs with the inability to collect.
This is a lopsided “heads I win, tails you lose” proposition that is at the heart of why these contracts need to be on an exchange – all of them. Berkshire wrote these contracts never expecting to have to actually perform, based on their analysis of historical precedent. Since these are European-style options (as a custom derivative) they cannot be exercised early, but since they’re effectively PUTs on the S&P 500 they’re based on a standard reference and there is no reason not to post them on an exchange.
Doing so means that the person holding them can trade against their “in the money” position while Berkshire is forced to prove capital adequacy now and forevermore during the time of their validity.
This is exactly how it should be and is in the regulated commodities, futures and options markets.
Berkshire’s request for “special treatment” must be denied.