The Berkshire - Goldman OTC derivatives connection

The following story upon Berkshire Hathaway's equity derivatives fiasco has been all though forgotten. This is surprising, given a recent push for derivatives regulation. The miss of coverage upon this is additionally surprising, given a final statement in a allude to next upon counterparty exposure.

The NY Times, May-2008: Berkshire pronounced it had a $1.2 billion pre-tax unrealized loss upon put options it wrote upon a Standard & Poor's 500 as well as 3 foreign stock indexes.

It additionally reported a $490 million pre-tax unrealized loss upon contracts which require payouts if a little high-yield holds default in between right away as well as 2013.

The bearing might at first seem odd given that, in his shareholder minute in 2003, Buffett called derivatives "financial weapons of mass destruction, carrying dangers that, while right away latent, have been potentially lethal."

But in his minute this year, Buffett pronounced Berkshire had already been paid for its derivatives contracts, giving it money to invest, and which "there is no counterparty risk."

That's right, Buffett's organisation was shorting long-term puts upon equity indices. Berkshire had no counterparty bearing upon these positions given they were options sellers, though someone patently had bearing to them. Long-dated bearing is formidable to acquire in distance over a year in term via sell traded options. Plus offered sell traded options will require a good understanding of margin in annoy of Berkshire's clever credit. That means these trades contingency have been over a opposite (OTC).

Buffett's false statement upon "financial weapons of mass destruction" contingency have meant which OTC derivatives have been OK as prolonged as someone else is taking a counterparty exposure. The question is who was which counterparty. It had to be a singular series of dealers to keep a trade secret. It additionally has to be someone who likes to be prolonged long-term volatility, given unwinding this choice risk could be costly. One organisation which stands out is Goldman. They have been well known to build prolonged choice positions by transacting with their clients. And they had been peaceful as well compensate some-more for those options than a foe given they were peaceful to own a risk. It is thus safe to assume Goldman was in actuality a pass Berkshire's counterparty upon these trades.

Given Berkshire's excellent credit, shopping puts from Buffett was a no-brainer in terms of counterparty bearing in 2007. But in a latter part of 2008, Goldman contingency have been getting nervous as a puts went deep in to a money as well as Berkshire owed Goldman a rapidly growing amount. In a environment of a time, nobody's disaster was off a table.

But then came this transaction:

The WSJ, September 2008: Goldman Sachs Group Inc. pronounced it will get a $5 billion investment from billionaire Warren Buffett's company, imprinting one of a biggest expressions of certainty in a financial complement given a credit predicament intensified early this month.
...
The understanding is structured in dual parts, giving Berkshire a stream of money as well as intensity ownership of rounded off 10% of Goldman. Berkshire will spend $5 billion upon "perpetual" elite shares of Goldman. These have been not automobile in to equity though compensate a fat 10% dividend.

Berkshire additionally will get warrants extenuation it a right to buy $5 billion of Goldman usual stock at $115 a share, which is 8% next a 4 p.m. shutting share price Tuesday of $125.05. At Goldman's rounded off $50 billion marketplace value, based upon which shutting price, exercising those warrants would give Berkshire about a 10% interest in Goldman.

Goldman additionally will go to a open to lift at slightest a serve $2.5 billion by offered usual shares. Once it does, Berkshire's interest -- if it has exercised a warrants -- would fall to about 7%. Goldman will have a right to repurchase a elite shares at any time for a 10% premium.

The idealisation question here is how a elite share purchase understanding was linked to a massive bearing Goldman right away had to Berkshire. In a way, a $5 billion money injection might constitute a nice "margin posting" to Goldman. Were a little of a put positions out as part of a deal? The mass media hasn't unequivocally connected a dots upon this, as well as it's not transparent because alternative than to most this is an aged story. But it definitely deserves another look.



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hat tip Ed.

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