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Buffett, a Longtime Derivatives Critic, Lobbies for an Exemption

In 2003, Warren Buffett called derivatives "financial weapons of mass destruction." But as Congress considers financial reform, he is now trying to have his company's derivatives portfolio grandfathered in.

April 26: It appears Warren Buffett won't be getting his desired derivatives exemption, which would have spared his company, Berkshire Hathaway, a financial blow. Senate Democrats are reportedly denying the provision despite the company's lobbying efforts.

Last week, I spoke with a former regulator who praised Democratic Sen. Blanche Lincoln's derivatives bill as "a high water mark" for regulation of the Wild Wild West that is the derivatives market.

But that bill could undergo major changes before getting worked into the broader financial reform bill currently in the Senate.

According to The Wall Street Journal, Warren Buffett's investment group, Berkshire Hathaway, has been lobbying for a clause to exempt existing derivatives contracts from proposed rules that would force companies to put money aside to cover potential losses in a deal. Derivatives, essentially bets on the future price of something, can be used to hedge against risk in a way that is similar to buying insurance. (Say, if you're a farmer and want to protect yourself against the price of grain falling.) They can also be used by parties with no financial stake in the price of the good, such as companies that simply place bets and make money if they win the bet. Such bets can be quite useful, because then there's somebody to take the other side of the farmer's hedge. (In Wall St. lingo, they help keep markets liquid.) But when speculation ends up dominating a particular market, that can lead to trouble.

In 2003, Buffett called these complex instruments "financial weapons of mass destruction." He likened the business of trading them to "hell... easy to enter and almost impossible to exit."

"I believe we may not know where exactly the danger begins and at what point it becomes a super danger," he said in 2007. "We don't know when it will end precisely, some point some very unpleasant things will happen in markets."

Now, three years later, faced with the prospect of tougher rules, Buffett wants his company's $63 billion derivatives portfolio to be essentially grandfathered in. To achieve this, he has lobbied Sen. Ben Nelson, the Nebraska Democrat to whom Berkshire and its employees have contributed $75,550 during his political career -- more than any other company.

The latest, toughest derivatives bill, sponsored by Sen. Lincoln and approved by the Senate Agriculture Committee, would force Berkshire and other companies creating derivatives contracts to put aside money upfront to cover potential losses. In the absence of such rules, insurance giant AIG essentially had to be rescued by the government when its bets went bad and the company lacked sufficient capital to pay up. As a result, the Treasury and Fed have spent about $140 billion on AIG's bailout. But Berkshire Hathaway, which analysts say may deserve an exemption because of its financial strength, is advocating a provision that -- if approved -- would apply broadly to all existing derivatives contracts, and not just its own.

From The Wall Street Journal:

The White House has been trying to kill the Berkshire provision on the grounds that it would weaken the government's ability to regulate the enormous market for derivatives. Berkshire Hathaway argued that it shouldn't be made to redo existing contracts and that it is already healthy enough to cover its obligations. The battle over the provision shows how lobbying by businesses and lawmakers to insert just a few words into a complex bill can have a major impact on the country's biggest companies.

The Senate could start debating the larger financial regulatory bill today.

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