Buffett Says Some Banks Too Big,
Complicated To Run
DOW JONES NEWSWIRES
May 3, 2008 3:53 p.m.
OMAHA, Neb. (Dow
Jones)--Some investment banks and commercial banks are too large and
complex to run, Berkshire Hathaway (BRKA) Chairman Warren Buffett said
Saturday.
"There are firms in terms
of risk that are conducting themselves in a way that makes them too big
to manage," he said.
Such financial
institutions are designed to survive only until there's a shock to the
system that may only occur once in 50 years, Buffett said.
"That may not be in the
interest of a 62-year-old executive, who will be around for the next
three years to worry about that," he said.
Banks and brokerage firms
have been hit hard by the mortgage-fueled credit crunch.
Financial-services companies in the Standard & Poor's 500 index have
lost roughly a quarter of their market value in the past year.
Concerns about brokerage
firms increased earlier this year when Bear Stearns (BSC), one of the
largest mortgage underwriters and derivatives traders, almost collapsed.
Bear had to be bailed out by J.P. Morgan Chase (JPM), which has offered
to acquire the firm for a knock-down price in a deal arranged with the
Federal Reserve.
As a result, the Fed has
also started lending directly to brokerage firms to help them avoid
liquidity crunches like the one that nearly felled Bear.
"The Fed did the right
thing stepping in," Buffett said.
If Bear had failed, one or
two other investment banks would probably have collapsed within a few
days, he said.
Bear had roughly $14.5
trillion of derivative contracts outstanding the day after it was bailed
out, he said.
"The parties that had
those contracts would have had to establish the damages that they could
claim against that estate very quickly," he said.
"Imagine the damage of
everyone trying to unwind those contracts," Buffett said. "That would
have been a spectacle of unprecedented proportions. It would have
resulted in another one or two more investment banks going down in a few
days."
Beware Of Derivatives
Buffett also pointed to
dangers connected with some derivatives markets.
Banks and brokerage firms
still have billions of dollars of exposure to mortgage securities, CDOs
and other complex derivatives. That makes it more difficult to judge how
leveraged they are and the companies' true values.
Credit default swaps (CDS)
are probably the fastest-growing part of the market for derivatives,
which are financial instruments that get their value from other
securities. CDS instruments offer investors protection against default,
and the notional value of these credit derivatives almost doubled to
$62.2 trillion last year.
Such explosive growth has
sparked concerns that if a major CDS counterparty got into trouble, the
financial system could collapse. Bear Stearns is one of the largest CDS
players in the world, so when the brokerage firm nearly collapsed,
authorities had to step in quickly.
Buffett has called
derivatives "financial weapons of mass destruction" in his 2002 letter
to shareholders, after trying to unwind such positions held by GenRe, a
big reinsurer Berkshire acquired four years earlier.
While Berkshire increased
its derivatives positions in 2007, Buffett said in his latest letter to
shareholders that the company holds the cash involved in these
transactions, eliminating counterparty risk.
Berkshire Vice Chairman
Charlie Munger said some banks have assets that he described as "good
until reached for" - assets that are considered valuable until firms try
to sell or unwind them.
He said the culture of
investment banks is in some ways "evil" and counterproductive to the
financial health of the U.S. Traders in such firms are often eager to
make overly risky investments, a practice that is difficult for the
heads of brokerages to stop, he said. This in turn puts too much risk on
the financial system as a whole, he said.
-By Michael Kitchen;
415-439-6400; AskNewswires@dowjones.com
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