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Buffett Now Sells Derivatives

TurtleTrader® comment: Buffett can be no clearer in the article below by Davide Dukcevich, published in Forbes. He thinks derivatives are junk:

Things are less lucrative in the stock market, Buffett said, sounding a familiar refrain. We have more money than ideas, he said, adding that 6% to 7% was a fair rate of return in the current environment. The company has more than $37 billion in cash to invest. One place the money certainly won’t go is derivatives. There’s no place with as much potential for phony numbers as derivatives, he said. Buffett’s 78-year-old billionaire vice chairman, Charlie Munger, couldn’t resist chiming in. To say that derivative accounting is a sewer is an insult to sewage.

Berkshire Hathaway issues first ever-negative coupon security

TurtleTrader® comment: Sixteen days later Buffett is quietly sang a different tune. His press release:

Omaha, Nebraska May 22, 2002 Berkshire Hathaway Inc. (NYSE: BRK.A and BRK.B), announced today that it has sold $400 million of a new type of security, named SQUARZ, in a private placement to qualified institutional investors. The initial purchasers will have an option to purchase an additional $100 million of securities to cover over-allotment. The issuance was upsized from $250 million due to strong market demand. The SQUARZ security, which was created by sole underwriter Goldman, Sachs & Co., is a unit consisting primarily of a Berkshire senior note due in 2007 and a warrant to purchase Berkshire common stock at a premium. The new security is believed to be the first security to carry a negative coupon. The warrants will give the holder the right to purchase either shares of the Company’s class A or class B common stock at the holder’s option. The initial exercise price represents a 15% premium over the closing price of the class A shares on the NYSE on May 21, 2002. The Notes will pay holders a 3.0% interest rate per annum and holders will pay 3.75% installment payments per annum on the warrants. The warrant payments due from holders will be greater than the coupon on the senior notes, effectively making SQUARZ the first negative coupon security. Berkshire Hathaway will use the net proceeds from the issuance for general corporate purposes, including possible acquisitions, none of which are pending. Despite the lack of precedent, a negative coupon security seemed possible in the present interest rate environment, said Warren E. Buffett, Chairman of Berkshire Hathaway. Mr. Buffett added, I asked Goldman Sachs to create such an instrument and they responded promptly with the innovative security being announced today.

TurtleTrader® comment: Buffett can create derivatives, but no one else? To the larger point though, Buffett seems to have been untruthful back on May 6, 2002. More from Jerry Knight, in The Washington Post:

Wall Street shelled out upward of a half-billion dollars last week after Buffett came up with one of the craziest-sounding deals ever: If you will pay me for the privilege, he said, I will let you lend me money. The deal produced a lot of head-scratching on the business television networks, much mindless chatter on the Internet and a spate of stories about what a strange deal it was, especially for Buffett, who is legendary for his K.I.S.S. investment strategy, as in Keep It Simple, Stupid. Buying good companies whose business you understand and that are available at reasonable prices has long been the Buffett rule. Following that strategy, Buffett bought the Geico Corp. insurance company when its stock was a bargain and has long been the biggest outside shareholder in The Washington Post Co. There is nothing simple about these bonds, known by the name SQUARZ, which is protected by a trademark that Goldman, Sachs registered so no one else could use it. Goldman, never as talkative as most other Wall Street firms, is being so closemouthed about this deal that it has not even explained what the acronym means. Buffett didn’t return calls seeking comment. Exactly what Buffett is up to is difficult to determine because the prospectus spelling out details of the deal has not been made public and few people on Wall Street have read it. A spokesman for a firm that manages $175 billion in assets said nobody there could explain it. Nor could two prominent specialists in convertible securities — bonds that can be converted into stocks. But Wall Streeters say there are certain kinds of investors for whom the Buffett bonds could be an attractive investment — even if they have to pay him money.

TurtleTrader® comment: Quite clearly one of Wall Street’s kings of keeping things simple has decided to go complex. We have been pointing out the hypocrisy of Buffett for years, maybe now that he is in the derivatives business some of his followers will at least pause in their hero worship — we doubt it.

Note: The TurtleTrader site will continue to offer a well-rounded slate of positive reinforcement articles along with critique articles. The combination of the two styles helps the learning process.

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