Mark-to-market (accounting) losses suffered during the quarter amounted to just $118 million, compared with $2,443 million a year earlier.
Those of you who attended the FL Seminar “The Big Short” may recall that Berkshire Hathaway (Mr Buffett´s firm) several years ago sold a ton of equity index put options and a ton of credit protection through credit default swaps. Buffett raised about $7 billion in premium upfront, which he most likely invested in the markets. He hopes that any eventual cash losses on his short derivatives positions will be more than compensated by the returns earned on those premiums (“float”, in the insurance jargon). Through the derivatives, Buffett is exposed to the folllowing risks: declining stockmarket prices, increasing stockmarket volatility, enhanced probability of credit problems, actual credit problems. Most of these derivatives have long maturity dates and Berkshire won´t have to make almost any cash payment (if at all) until those dates. Berkshire seems not to be beholden to its derivatives counterparties through collateral agreements, so temporary accounting losses would not transform into real losses.
While credit swaps recovered in value in Q3, the equity puts lost another $500 million in value.
Notional amount of the equity puts is $34 billion and that of the credit swaps is $15 billion. The current MTM liability for Berkshire is $10 billion.
Berkshire had total revenues of $117 billion in the first nine months of the year and net earnings of $10 billion.
Derivatives gain/losses go into earnings (these are not hedge products).
So Buffett´s big bet against the Black Swan has had an overall not so bad recent quarter. But, like any other derivatives shorty, he continues to expose his firm to the “rare” event making an appearance and blowing up those who dared challenge it.