-redit Default Swaps

WARREN BUFFETT: The credit default swap market — you can see these figures — and I’m repeating them, but I’m not validating them — but the last number that came out was over 60 trillion. Now, there’s lots of double counting in these things and all that sort of thing. But there’s no question there’s a lot of money on both sides of the credit default market. They call them credit default swaps. You can think of it as insurance against a company going bankrupt. And actually, we have written two types of derivatives on a big scale. We explained them in the annual report. We explained them again in the press release that was issued yesterday. And we have insured in the — we’ve written insurance that pays off to somebody else in the event of default by companies listed on given indices. There’s a high-yield two, a high-yield three, and so on, through high-yield nine. And we’ve written various traunches of risk on those things, and I think we’re going to make significant money, although we could lose money, too. It will depend on credit experience in the next few years. I think there’s no question that the corporate default rate will rise. That’s been cranked into the calculations I make in writing this insurance. The question of whether the credit default swap — the size of that market — will lead to any kind of chaos in the financial markets, I think probably not. Although if a Bear Stearns had failed, for example, you would have had a huge unwinding of contracts by counterparties who had to establish their claims and all that. So you would have had rather chaotic conditions. Any time — a credit default swap is merely a payment by one party to another. So it’s a negative-sum item. When somebody loses money on a subprime loan, on a mortgage loan, they’ve lost real money. Now, somebody may be buying the house later on cheaper than they would have bought it earlier on, but there is not an equivalent swap of dollars at the time that a subprime loan goes bad. With the credit default swaps, there is a swap of dollars. So as long as the counterparties pay, if A is up a million dollars, B is down a million dollars.