Warren Buffett: $516 trillion bubble is a disaster waiting to happen

http://www.marketwatch.com/news/story/derivatives-new-ticking-time-bomb/story.aspx?guid=%7BB9E54A5D%2D4796%2D4D0D%2DAC9E%2DD9124B59D436%7D

by makimaki • 18 years ago

22 13 18 years ago

marketwatch.com

Xichekolas• 18 years ago

It would be helpful if he would actually explain how this meltdown would occur, rather than just yelling about how crazy terrible it will be. I personally know little about derivatives and how they work, other than they seem to be a way to securitize a bet on a non-equity occurrence ... like the Giants winning the Superbowl or a storm killing the Florida orange crop.

dpapathanasiou• 18 years ago

Here's an example of how these gyrations affect municipal bond investments: http://avc.blogs.com/a_vc/2008/03/our-run-in-with.html

Another example is Comerica's apparent misstep with its money market funds: http://venturebeat.com/2008/03/11/credit-crunch-hits-start-u...

You'll start seeing more stories like these.

rp• 18 years ago

I agree with this statement and will make an additional comment.

I wonder to what extent Warren Buffett's treatment as a oracle by the financial press creates a non-helpful feedback loop where complex financial activities that can't be reduced to simple homilies (i.e., buy low, sell high) are immediately viewed as inevitably catastrophic and diabolical.

I say this with particular focus on the notion, which is once again stated in this article, that if Buffett doesn't understand it, who does? Apparently, a whole lot of very very smart people understand these systems (exotic financial instruments, electronic trading systems) enough to make them a significant part of the modern economic structure. Certainly, there is something more complex and nuanced going on here but you would not know it from the way the press (via Buffett) is presenting it.

marvin• 18 years ago

As far as I can tell, this entire article was based on two sentences in Buffett's letter to shareholders six years ago. Buffett is obviously a financial genius, but it isn't very easy to see exactly what he meant from these two sentences. Basing two entire pages of doom and gloom on that with nothing but arbitrary statistics to back up the point doesn't seem very trustworthy to me. If the author is serious that there is a massive bubble flying under the radar, he's not making a particurlary solid argument.

Headlining this story 'Warren Buffet: *' is very misleading. Please don't.

daniel-cussen2• 18 years ago

...

I don't know if the article's right or not, but...

I couldn't get over the figure...$516 trillion is...a lot of money. I thought the total wealth was closer to $125 trillion...wow. Of course, there are issues with how you count this money, and whether it's real or not, but, damn, 516 trillion...that's almost a quadrillion.

516,000,000,000,000.

5.16 x 10^14

Damn.

Of course, I'm sure we'd all give a quadrillion quadrillion for two seconds of joy.

byrneseyeview2• 18 years ago

The way they get that number is something like this: imagine a small economy with one oil well, one gas station, and one commuter, and one speculator. The oil well owner pre-sells $1000 worth of oil to the gas station (that's $1000 in notional derivative value). The gas station owner pre-sells the same amount of oil to the commuter (that's another $1000). The commuter decides he'd rather walk, after all, and sells the same value of oil to the speculator ($1000). The speculator decides he'd rather play the soybean market anyway, and looks for someone who wants to trade oil. Alas, the only person who feels good about oil is the oil well owner, who is willing to buy $1000 worth of oil from the speculator.

Since nobody has canceled any of their speculative contracts, the notional value of the derivatives is the sum of the value of all of the trades: $5000. And yet, all but one of the participants made a positive bet (buying $1000 worth of oil) followed by an exactly-offsetting negative bet (selling the same amount of oil). So they all net out to zero, except the oil-well owner; we're all back where we started.

The problem is credit risk. If the gas station is destroyed in an earthquake, the commuter may not be able to collect on his bet with the station owner, and may thus be unable to pay the speculator, who may thus be unable to pay the oil well owner, forcing everyone to cut their spending or possibly even default. But in this case, it takes an outside catalyst, and the problem is not the derivatives themselves. The problem is credit risk. Also, earthquakes.

delackner• 18 years ago

My own understanding of derivatives is very weak, but could someone extend this example to explain what the resulting state would be in this chain? Simplifying a little, a->b->c->a (a loop), where -> is "owes $1000". So party A dies, leaving B in the hole, right? This seems like a recipe for massive implosion, an unstable system ala a mountain of sand. Destabilize one grain, somewhere, and you get an avalanche.

daniel-cussen2• 18 years ago

Didn't know this. Thanks.

paul• 18 years ago

I bet $100 trillion that this isn't as big of a problem as they are claiming.. Oops, now it's a $616 trillion bubble!

The fact that this is going on outside of the regular banking system seems like a feature to me.

Hexstream• 18 years ago

I'm afraid we'll have to do much more than just breaking your legs for a 100 trillion debt...

freedomguy• 18 years ago

Buffett didn't say $516 trillion. The headline is completely wrong.

BIS estimates that amount, but its really misleading...its a measure of the nominal size of the derivative and not the actual financial exposure.

Warren Buffett: $516 trillion bubble is a disaster waiting to happen

Related Stories