naked capitalism

RK says:

Yves: Please help us with something. Brad Setser in his most current post indicates that almost 300 billion
of Lehman Bonds (unclear if all were issued BY Lehman
or “linked” to Lehman ) were owned by Chinese state
or central banks. I know the balance sheet was supposed to be around $600 B. Any light you can shed on this?? I thought Lehman only had around
$110 B of bonds outstanding.

dividedmind says:

Yves:

It would be interesting to figure out how much Buffett is on the line if a market crash were to occur. Berkshire received $4.5 billion for writing puts on the S&P and 3 other foreign indexes over the past year or so. The mark to market losses on these could be pretty astounding if the Dow were to fall to, say, 8,000. I think the liability here totally dwarfs the investment in Goldman, though I can't say by how much. It would be amazing if the sage were brought low by the financial crisis, having employing AIG-like strategies in writing insurance on the stock indexes.

The details of the Buffett transaction are summarized below, from the futureblind blog back in March, though we may fairly doubt if it was such a brilliant speculation after all.
http://www.futureblind.com/2008/03/berkshire-part-2-selling-puts/

"Buffett has pulled it off again. He’s made a creative, favorable bet that may pay off handsomely for long-term Berkshire shareholders.

Over the past year, Berkshire Hathaway sold put options on the S&P 500 and three foreign indices. Expiration of these puts range from 12 to 20 years out, and Berkshire collected $4.5 billion in premiums. Unlike regular puts, these are exercisable only at their expiration dates. On those dates, Berkshire makes a payment only if the index has lost money over the period of the option.

Selling these puts is essentially saying: In 15 years, I promise to buy the S&P 500 from you at a price of $1,468 (closing 2007), if it trades below that price. In exchange, you give me $4.5 billion right away.

Buffett doesn’t disclose the size of the actual options. The $4.5 billion in premiums tells you they are big, but apparently not big enough relative to Berkshire to cause any problems.

The counterparties (the people who made the agreement and paid the premium) are most likely large financial institutions who are hedging their long-term bets in favor of the market. So it may turn out to be a dumb bet for them, but they’re essentially purchasing insurance on what they have or will have in the market.

For Berkshire to lose money, a few things have to happen. To keep it simple, let’s just talk about the S&P 500, because we don’t know which foreign indices were used.

1. First, over the next 12 to 20 years, the market would have to have a negative cumulative return.
2. Second, that negative return would have to be large enough to overcome the premiums received.

How large? Once again, we don’t know the size of the options. But the premiums, which were $4.5 billion at the time they were written, will have compounded for more than 15 years by the time of expiration. If Buffett (or future Berkshire managers) can achieve 15% annual returns, the premium cash will have grown to over $36 billion. So the aggregate losses on the put options—the size of the options times the amount of negative returns—would have to exceed $36 billion for any profits to be erased.

Because of their long-term length, it mitigates the risk of a short-term Black Swan-type event affecting the options. A “Black Monday” one day anomaly would have little effect, other than a temporary quarterly adjustment. Something could still happen (i.e. a long depression, or a nuclear war, God forbid) that would cause losses. But this bet seems pretty favorable as long as the world economy does alright in the long run. Chalk one up for the Oracle of Omaha."

Anonymous says:

“It would be amazing if the sage [Buffett] were brought low by the financial crisis, having employing AIG-like strategies in writing insurance on the stock indexes.” — dividedmind

It’s looking like a classic “race to the bottom” between Bernanke and Buffett.

At first glance, Bernanke would appear to be light years ahead in the race to liquidation or conservatorship, having trashed his balance sheet to the tune of hundreds of billions in just the last two weeks.

But Buffett, having made an enormous bet in favor of conventional thinking and the government-managed status quo, may yet come from behind and pip young Helo Ben in the stretch.

Godspeed, gentlemen! Just remember — it’s only paper money!

– Juan Falcone

RK says:

Thanks bob_in_ma: I haven’t seen the work Millions
in so long I just misread it as Billions.

Anonymous says:

The problem:
Mark-to-market accounting.

The solution:
Mark-to-Hank!

Anonymous says:

Chinese state banks have admitted to holding 300 million (not billion) of LEH bonds. SAFE likely has some as well, but the sum isn’t going to be that large —

bsetser

buermann says:

Woops, how’d this end up in this thread.