Buffett's most outrageous comment on derivatives!

Jul 20, 2012

In this issue:
» Consumption dips in rural India
» Maruti workers resort to violence and murder!
» Will this Bill be as noble in reality as in theory?
» Do Chinese steel exports pose a threat to global steel players?
» ...and more!

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Exactly a decade ago in Berkshire Hathaway's 2002 annual report, legendary value investor Warren Buffett had very aptly commented, "The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear....[They] are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." His prophecy indeed came true in the form a worldwide financial crisis that was triggered by the collapse of the giant investment bank Lehman Brothers in 2008. The crisis left some serious fractures in the macroeconomic landscape that the global economy is still struggling with.

In the meanwhile, big banks seem to have learnt little from the crisis. Take the case of J P Morgan Chase, the bank which had so far the best reputation on Wall Street. It was relatively less affected during the 2008 financial crisis. But things have turned 180 degrees thanks to the reckless trading in complex credit derivates by "London Whale" Bruno Iksil, the JP Morgan trader. The most worrying aspect is that the exact quantum of losses are yet unknown. Initial estimates had pegged the losses at US$ 2 bn. More recently, the bank has elevated the figure almost three times to about US$ 5.8 bn. And this could even grow further to over US$ 7 bn.

Whatever be the loss figure, what led to such a catastrophe for J P Morgan? One reason is that the bank plunged into derivatives that were too complex to understand or control. Moreover, internal investigation has found evidence that some rogue traders may have tried to hide losses. This is hardly surprising.

But some recent remarks by Mr Buffett on the "London Whale" blunder really surprised us. For one, he brushed off the slip-up by J P Morgan citing that the losses were not significant relative to the size of the bank. He went on to justify by explaining that even events like hurricane Katrina and the 2011 terrorist attack had caused billions of losses. Moreover, when asked whether this incident would affect the bank's reputation, he said, "I've had enough mistakes of my own that I'm very forgiving when something like that happens." It would be difficult to believe that these are the words from the veteran investor had we not known that he has a personal stake of about 1 million J P Morgan shares.

In our view, the "London Whale" blunder is not a one-off event that could be ignored. It lays bare some very telling facts about the too-big-to-fail institutions. For one, it is another proof of the immoral and unscrupulous tendencies of the banking class, which are supported to a great extent by the undemocratic benevolence of the central banks such as the US Fed. On another note, it points out the colossal risks associated with extremely large financial institutions, many of which have balance sheets the size of countries. These big banks are certainly too big and complex to manage and regulate. They pose a big threat to the larger economic environment and society.

Do you think Warren Buffett is right in supporting J P Morgan Chase? Share your views with us or you can also comment on our Facebook page / Google+ page.

 Chart of the day
Today's chart of the day shows a significant slowdown in sales volume growth of consumer goods during June 2012 as compared to a year earlier. As per data compiled by market research firm Nielsen Co., the rural Indian markets have been the worst hit. Volume growth of packaged consumer goods has become muted in these markets. The likely reason for the same is the deficiency in rainfall during the month of June 2012. It must be noted that rural India comprises about two-thirds of India's 1.2 billion population.

Data source: Nielsen Co.

Maruti Suzuki had a rather forgettable FY12 wherein a prolonged strike at its plant in Manesar wreaked havoc on the company's fortunes. One major bone of contention was that half of the workers employed there were contract workers who were paid lesser than permanent employees for the same work done. It did not help that this development coincided with a slowdown in the economy and consequently the auto sector. The issue since then was resolved and thus there was a pick-up in sales volumes for the company. But incidents over the last couple of days have left a bitter taste in the mouth. In a scuffle between the management and workers, the latter resorted to violence and murder. This means that the plant in Manesar has been shut down and production halted. No doubt this will impact sales at Maruti. Especially since the Manesar plant manufactured the Swift hatchback, the Swift Dzire sedan, SX4 sedan and the A-star small car. The Maruti management will need to do some soul searching with regards to employing contract workers and that too making them work along with permanent employees. But we believe that whatever 'wrongs' the workers may claim against the management, such acts of violence are highly condemned. Issues need to be sorted out through talks, discussions or through legal recourse. Certainly not through acts of violence!

There is once again a ruckus about India's proposed Food Security Bill! No doubt the intention is noble. Providing food at dirt cheap rates to the poorest of poor is indeed a noble idea. Not only will it solve the problem of hunger and starvation. But it could also mean some meaningful usage of the excess food crops that is currently rotting in the open. But what if we told you that the scheme is supposed to feed 869 million people? By every stretch of imagination, feeding such a vast majority is no mean task. And with the Indian government hoping to execute the same with the food subsidy scheme, we seem to be stepping onto another disaster. The revised bill proposes to include 70% of Indians. Also it will include almost 90% of the population in 250 poor districts in the country. On one hand, the subsidies for the successful implementation of the scheme could break India's economic back. On the other, we can already imagine corruption seeping through the magnanimous scheme. Instead of focusing on providing employment for better livelihood to the poor, the government continues with its fiscal profligacy. We wonder if our policy makers have read the quote "Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime."

The steel industry in India is facing many issues like raw material availability and prices, land acquisition, demand crunch etc. China, the largest consumer of steel is also witnessing a cooling of economy. As a result, their demand for steel has decreased. Many Chinese mills are reported to be making losses and have already opted for production cuts. This is forcing Chinese steel manufacturers to export their products. China's slowing demand for steel is driving Chinese exports of the metal to the highest level in more than three years. Thus flooding the Asian market with supplies at a time when global producers are grappling with thinning profits. Earlier, Europe used to soak up most of Chinese exports. But the debt crisis and slowing economy has caused Chinese companies to turn their shipments to destinations closer to home. So do the Chinese steel exports pose a threat to global steel players? If this happens then the global steel industry could go into a new era wherein a return to the anti-dumping actions would take place as well as risks of having excess capacity, which arose several years ago, could once again top the concerns of the world steel industry.

In a move that would provide the much needed boost to the dull sentiments towards investments in infrastructure; the government has created a new body to expedite clearances and review major projects in the oil & gas sector. The Project Clearance Board, as it is termed, would be headed by the Cabinet Secretary. It would include representatives from the ministries of home, defence, environment and forests, commerce, coal, department of space and other infrastructure and energy-related departments.

The decision to create this body was taken at a meeting held by the Prime Minister's Office (PMO) for reviewing the progress on various oil & natural gas exploration projects under the New Exploration Licensing Policy. Amongst the many clearances that this body would review and issue, security clearances (which are considered to be "one of the biggest hurdles" for infra projects) would be issued by the body as well.

In the meanwhile, indices in the Indian equity markets were trading weak today with the BSE-Sensex down by more than 90 points at the time of writing. Amongst sectoral indices, Oil and gas and banking sector witnessed maximum losses. The key market indices in Asia also were also trading in red while Europe opened on a mixed note.

 Today's investing mantra
"The extraordinary thing about the securities market, if you judge it over a long period of years, is the fact that it does not go off on tangents permanently, but it remains in continuous orbit." - Benjamin Graham

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11 Responses to "Buffett's most outrageous comment on derivatives!"

r v iyengar

Jul 23, 2012

Can't give much credence to what Mr.Buffet says in this instance. the moment he is an interested party, his comments are coloured.
I am inclined to comment on another part of the article on food security Bill. whatever happened to the good old Garibi Hatao slogan/program of Congress. The number of people qualifying to receive assistance under FSB seems to be far too larger than what could be anticipated.
Shining India seems to be dimmed beyond recognition.



Jul 23, 2012

Buffett’s time’s up. He is making terrible blunders in his comments these days. Same had happened to Philip Fischer who made silly investment decisions in his last days. Everything and every person has it’s/his ups and downs. Buffet is no different. He has lost it.



Jul 22, 2012

First and foremost, Mr.Buffet is a businessman, so though he will advise against derivatives trading, when it comes to a "derivatives blunder" by one of the companies where he has a substantial stake, he will go all out to defend the company as otherwise he would end up on the losing side if the stock plummets due to his adverse comments.


B. N. Bhat

Jul 22, 2012

21 July 2012
We all know when a "Right is a right and a "Wrong is wrong" and make no mistakes about it. They knew what they were doing when they were playing with other peoples money. Who know how many poor people were ruined. Follies of youth could have been made by Mr Warren and hence could be forgiving. But to forgive rogues is unpardonable. Their place is in a jail and not in the sunshine.



Jul 21, 2012

In this fast moving electrical track, world economy movest at a dangerous pace. Hence, there cannot be a generalisation and each event must be viewed and commented on each merit/demerit.

The gospel word is that corporate greed must be controlled through stringent controls and all corporates must be sent to schools where they can learn ethics and humanity.


ajay kumar tetwal

Jul 21, 2012

Mr Buffet's comments reflect his sincerity and responsibility towards common shareholder public as he very well know that his adverse comments can make a dent in the reputation of bank.


sunilkumar tejwani

Jul 20, 2012

fully agree with Mr. Karl. A vested interest in any investment (read stocks) will always sing songs in praise of the investee company regardless of performance. This is it.



Jul 20, 2012

On Maruti issue,Whatever may be case. Taking a life can never be justified. Children have been made orphans, a family destroyed for ever. This act is inhuman and condemnable.



Jul 20, 2012

Maruti management must do "soul searching" for their unfair/exploitative practices whereas the temp workers must be "condemned" for their violent acts.
Law and order must be maintained under all circumstances...even when laws are unjust and the order favors select few.
The real issue is not being raised at all...*WHY* did Maruti management do this? Is it because Maruti management is full of inhuman parasites? The real issue is that our labor laws are antiquated and need a big overhaul. They currently favor select few organized workers at the expense of a large number of unorganized workers.



Jul 20, 2012

Regarding your article on Maruti Suzuki strike in today's issue, I feel that it is nothing less than adding salt to the wound of the Workers.

You accept the claim of the Workers against the Management disparity with permanent employees and contract labourers, but you want issue to be sort out through legal means. Instead of condemning the act of the Management, you advise / expect Workers to taken legal course.

Do you mean to say that you do not know the legal route followed in India and how lengthy in time and money it is ?
Do you expect Workers, who are getting a meager salary in compensation of their hard long hours of work be able to take up the issue through legal route. Not to bear these issues, Workers take it to the streets, where again government and columnist like you, who scribble in favour of Managements, come to the rescue (of Management).

Instead you could have advised Managements to share a part of their profits with their Contract labourers, who are the back bone of such massive factories making huge profits, and keep them happy. You too know that in majority of factories in India, permanent workers are only to the tune of 20% to 30% and balance are contract labourers. However, the profits are shared only within the share holders, Management, and the 20% permanent workers. The contract labourers are paid nothing more than their always paid daily wages.

I am sure, in the near future, unrest within the working folks will come up in the street and again you will write an article on that too, but I do not know in whose favour it will be.

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