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Sunday, May 04, 2008 11:23 PM

Buffett Loses $1.2 Billion Shorting PUT Options

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The New York Times is reporting Berkshire Net Off 64 Pct on Derivatives.

Warren Buffett's Berkshire Hathaway Inc (BRK) said on Friday that first quarter profit tumbled 64 percent, hurt by losses tied to derivatives contracts and a steep slide in insurance premiums.

Net income for the Omaha, Nebraska-based insurance and investment company fell to $940 million, or $607 per Class A share, from $2.6 billion, or $1,682, a year earlier.

Operating profit fell 13 percent to $1.93 billion, or $1,247 per share, from $2.21 billion, or $1,434. On that basis, analysts on average expected profit of $1,477 per share, according to Reuters Estimates. Revenue tumbled 24 percent to $25.18 billion.

Results suffered from $991 million of after-tax losses tied mainly to contracts designed to make money if junk bond stay out of default and stock indexes rise.

"When people see these derivatives numbers, they may be concerned, but Buffett gets his cash up front, so I'm not concerned about balance sheet integrity," said Thomas Russo, a partner at Gardner, Russo & Gardner, which invests more than $3 billion.
My Comment: When you short you get your cash up front by the very nature of shorting. The statement by Russo makes no sense to me.
Berkshire said it had a $1.2 billion pre-tax unrealized loss on put options it wrote on the Standard & Poor's 500 and three foreign stock indexes.

It also reported a $490 million pre-tax unrealized loss on contracts that require payouts if some high-yield bonds default between now and 2013.

The exposure may at first seem odd given that, in his shareholder letter in 2003, Buffett called derivatives "financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

But in his letter this year, Buffett said Berkshire had already been paid for its derivatives contracts, giving it cash to invest, and that "there is no counterparty risk."
My Comment: The very nature of short selling is such that one receives cash up front for future liabilities. Thus Thomas Russo is parroting Buffett. However, both may as well be trumpeting 1=1. More to the point, the statement "giving it cash to invest" is complete nonsense. Short selling gives one cash to invest only if the short works in your favor. In this case Buffet has $1.2 less to invest because so far he is underwater on his short by $1.2 billion.
He also said shareholders should be prepared for gains and losses that could "easily" top $1 billion in a given quarter.
My Comment: I agree with that. Anyone short S&P puts is asking to have their heads handed to them on a platter.

Buffett Bets On Europe

The Telegraph is reporting Warren Buffett bets his bottom dollar on European businesses.
Warren Buffett has fuelled suspicions that he is set to turn his sights on British companies by declaring he is now particularly focused on buying European businesses.

This weekend, at the annual general meeting of Berkshire Hathaway, Mr Buffett said he was keen to diversify away from companies whose business was largely in dollars, since he expects the US currency to lose more value in the coming years.

He said: "We are happy to invest in businesses that earn their money in the euro, or in companies that derive their earnings in Germany, or from the sterling in the UK, because I don't have a feeling that those currencies are going to depreciate in a big way against the dollar.

I'm willing to bet the dollar will weaken against other currencies over the longer term, so I feel no need to hedge those currencies."
The weakening dollar is one thing. However, the dollar may be counterbalanced and then some by falling share prices in the EU and the UK. There is also the possibility the dollar strengthens (at least short term), further compounding things for Buffett.

Buffet Calls Credit Crisis Bottom

Bloomberg is reporting Buffett Says Credit Crisis Ebbs for Wall Street Firms.
Warren Buffett, chief executive officer of Berkshire Hathaway Inc., said the global credit crunch has eased for bankers, and the Federal Reserve probably averted more failures by helping to rescue Bear Stearns Cos.

"The worst of the crisis in Wall Street is over," Buffett said today on Bloomberg Television.
Buffett Is Early

Warren Buffett's mistake is not comprehending the magnitude of the derivatives mess, the magnitude of the fallout of the housing bust, and the magnitude of the fallout of a global credit boom now going bust. The economic reality is that this is closer to 1929 as opposed to 1987.

It's tough betting against Buffet, but I think Buffett is extremely early. This global credit bust is going to astound practically everyone, including the bears.

Mike "Mish" Shedlock
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