Is Warren Buffett blind to tail risks/risks of ruin?

[newwurldmn]

I disagree with this characterisation...

@sle might have more specifics of how these were structured.

My recollection was that Goldman was screwed because buffet owed them and they couldn't force a margin call, while they owed a margin call on their hedges.

Buffet was screwed because the liability was going to hurt his credit rating as he was about to buy the railroad company. In the end Berkshire lost its AAA rating and the trades were restructured down and out.

 

[Maverick74]

Maverick74,
Do you have a good book/other reference that provides details about that week? I lived through it as a new B-school grad but wasn't in the industry, and at the time there was a lot of incomplete information and I never went back and put together the details afterward. I'd be interested in reading something that wasn't a "bankers are all evil" credo that provided an honest description of the things you described above, if you have any recommendations?

There was actually an academic paper floating out there discussing the trade. I stumbled upon it accidentally at the time. I can google around for it. The paper attempted to actually provide a synthetic price for where the trade was at it's worst levels. Since we are not privy to the actual marks this was all theoretical in the paper but it was interesting none the less. I'll look around.

 

[sle]

@sle might have more specifics of how these were structured.

Yes, I know these trades and (for lack of a better description) am intimately familiar with one of the legs. There were a few variations of various degrees of exoticity, from a vanilla 10 year put on SPX to 15 year worst-of put on [SPX, NKY, SX5E] x USD.

It was a very smart trade for them. The crux of the issue was the as a AAA entity they were not posting margin. So this automatically became a funding vehicle for them (and a serious funding risk for the dealers). In fact, the couple dealers that I know still have it on are still suffering.

There was zero probability for that trade to take them down the way it was structured but it did contribute to their loss of AAA rating later.

 

[Daal]

Yes, I know these trades and (for lack of a better description) am intimately familiar with one of the legs. There were a few variations of various degrees of exoticity, from a vanilla 10 year put on SPX to 15 year worst-of put on [SPX, NKY, SX5E] x USD.

It was a very smart trade for them. The crux of the issue was the as a AAA entity they were not posting margin. So this automatically became a funding vehicle for them (and a serious funding risk for the dealers). In fact, the couple dealers that I know still have it on are still suffering.

There was zero probability for that trade to take them down the way it was structured but it did contribute to their loss of AAA rating later.

I agree, that trade couldn't have taken brk down but apparently, Buffett thought his company was at risk of going under that year. From thorp's book

 

[Alexpung]

I am sure his goal aren't maximize value of his portfolio so talks about the Kelly are moot.

Why all-in and not play it safe? If all rich guys nit up and "play safe" the country will be hopeless.

Some of the guys are here to shape the world, and will not stop taking risk because they have enough money to last forever.

 

[Maverick74]

An interesting side note on this whole fiasco was Buffet bought 5 billion in long term warrants on GS that he also had exposure to had GS gone under. He bought those at good prices in 2008 in the middle of the crisis. Not sure about the ethics of that making a massive investment in the firm that is providing the liquidity for you to take a lot of risk.

 

[Superstar2317]

A few weeks back, I posted details of this trade: https://www.elitetrader.com/et/threads/how-to-make-a-killing-with-options.313633/#post-4522970. Here is the direct link for the lazy: http://www.cboe.com/blogs/options-hub/2017/02/25/update-on-the-warren-buffett-put-trades

At the time, Berkshire had $35B in cash, and they didn't buy Burlington Northern till 2009, in a deal worth $34B. Even now, they have $40B or more, I believe in cash. As for, the warrants, he got a sweetheart deal...10% interest, something like 10% of GS with warrants around $115, and lost a nice paper profit when he didn't convert in the $140's only for it to fall back under his $115. They eventually bought him out, a few years ago, giving him $2B in profit.(http://blogs.marketwatch.com/thetel...on-on-crisis-era-investment-in-goldman-sachs/)

 

[matthewyoung]

The US could have imploded but the rest of the world didn't had to (at least, not to the same extent). If you look at in the 30's, lots of countries had GDP collapses much smaller than the US. Switzerland/Luxemburg and other places would likely still to be safe havens, he could have taken his safe cash and put in those places ("just in case"). That would be buying ruin protection. He could have just doubled down with his Berkshire assets, but no, he took it all 100% of everything and put it all on the same thing on the belief that the US always comes back. At 78 years of age. Just seems a little nuts to me

Santa claus theory-the belief in something is that something. US always comes back because people like Buffett believe it will.