On Buffett's Big Bet on Global Markets (BRKA)

Apr. 7.06 | About: Berkshire Hathaway (BRK.A)

Over the past few days, there have been several stories written about Warren Buffett’s $14 billion bet on global stock markets. I believe these stories are all in reference to this disclosure in Berkshire Hathaway Inc.’s (BRKA) annual report:

Berkshire is also subject to equity price risk with respect to certain long duration equity index put contracts. Berkshire’s maximum exposure with respect to such contracts is approximately $14 billion at December 31, 2005. These contracts generally expire 15 to 20 years from inception. Outstanding contracts at December 31, 2005, have been written on four major equity indexes including three foreign. Berkshire’s potential exposure with respect to these contracts is directly correlated to the movement of the underlying stock index between contract inception date and expiration. Thus, if the overall value at December 31, 2005 of the underlying indices decline 30%, Berkshire would incur a pre-tax loss of approximately $900 million.

It’s impossible to evaluate exactly what this means for Berkshire (or what it tells us about Buffett’s thinking) without knowing more details. But, there are a few things I’d suggest you consider when reading the news reports.

First, the $14 billion headline number makes this bet look larger than it really is. According to the above disclosure, a 30% decline in the underlying indices would only create a $900 million pre-tax loss. One article stated that a decline in the indexes to zero was highly unlikely given historical trends. It’s a lot more than highly unlikely. But, since we don’t know the details of Berkshire’s exposure, we can’t evaluate the real risk of a very large loss.

A lot of these news stories have called Berkshire’s “long duration equity index put contracts