By Betty Liu and Erik Holm
March 12 (Bloomberg) -- Billionaire Warren Buffett said Berkshire Hathaway Inc. plans to sell more derivative contracts, a tactic some investors have said may cause the insurer to suffer billions of dollars in losses.
“Oh, we’ll continue,” he said in a Bloomberg Television interview, portions of which will be broadcast today and tomorrow. “We do anything that I think I understand and where I think that the odds strongly favor making money, which doesn’t mean you make money every time.”
Berkshire’s stock has plummeted this year on concern that Buffett’s bets on derivatives -- which he has called “financial weapons of mass destruction” -- will crush profit at the Omaha, Nebraska-based insurer. Berkshire is backing derivatives tied to corporate junk bonds, municipal debt and the performance of stock indexes on three continents, with liability of more than $14 billion as of Dec. 31.
The company’s liability could grow, or shrink to zero, by the time the contracts come due at set dates as many as 19 years away. The increase in liabilities on 251 derivatives, coupled with a drop in equity holdings, last year contributed to the steepest decline in the book value per share in Buffett’s 44-year tenure.
Book value, a measure of assets minus liabilities, still outperformed the return of the benchmark Standard & Poor’s 500 Index in 2008. Buffett gives both figures on the first page of Berkshire’s annual report each year.
The maximum loss on those bets was $63.4 billion as of Dec. 31, a figure that Berkshire would pay only if the markets fall to zero and all states and municipalities fail to pay their obligations. Berkshire has received more than $8 billion from unidentified firms that purchased the derivatives. Buffett, 78, whose investments are closely followed by individuals and professionals because of his reputation for beating market averages for decades, gets to spend the cash on Berkshire’s behalf until the claims come due.
“We got paid the appropriate premium,” Buffett said. “Every one of them was written by me, and I may be wrong on some of them. I’m sure I will be. But the question is, how will they turn out as a group?”
Any future derivatives sold by Berkshire will also be negotiated by Buffett, he said. “I’ll be the only one who does it,” he said. “I don’t delegate that.”
Berkshire stock has fallen 37 percent in the past year before today, and credit-default swaps used to guard against losses on Berkshire’s debt last week soared to record levels more typical of junk-rated companies. Junk bonds are high-yield securities graded below BBB- by Standard & Poor’s and Baa3 by Moody’s.
Buffett, who has been spending Berkshire’s cash on preferred shares and debt of companies including Goldman Sachs Group Inc., General Electric Co., and Harley-Davidson Inc., said he hasn’t grown more cautious about shepherding capital as liabilities on the derivatives have increased. Berkshire had $25.5 billion in cash as of Dec. 31, compared with $44.3 billion a year earlier.
“I have to be thinking about all kinds of worst-case risks that we have, and even maybe two of them occurring at the same time, or very close to the same time,” Buffett said. “That’s why we have a lot of capital -- a lot of cash.”
The largest portion of the derivatives, with total potential losses of $37.1 billion, are on so-called equity puts tied to the S&P, the U.K.’s FTSE 100 Index, the Dow Jones Euro Stoxx 50 Index and Japan’s Nikkei 225 Stock Average. Berkshire wouldn’t begin paying out on any losses until at least 2019. The four indexes would all have to fall to zero for Berkshire to be liable for the entire amount at risk, which can fluctuate with currency valuations.
“There’s a possibility of loss on any given contract,” Buffett said. “There should be an expectation of profit, but there’s a possibility of loss.”
(Portions of the interview with Buffett will be broadcast today and tomorrow on Bloomberg Television and at BTV on the Bloomberg terminal.)
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