Berkshire Hathaway on Cusp of Oversight by Fed Under Risk Council Criteria

Warren Buffett’s Berkshire Hathaway Inc. (BRK/A) may be on the cusp of getting Federal Reserve oversight under a proposal by regulators that also increases the chances that American International Group Inc. (AIG) and MetLife Inc. (MET) will receive heightened scrutiny.

Berkshire had $29.7 billion in credit-default swaps linked to its debt as of Oct. 28, putting it just under a $30 billion threshold proposed last month by the Financial Stability Oversight Council. AIG, now majority-owned by the U.S., had $45.3 billion in swaps written against it, and MetLife, the New York-based insurer, had $32.9 billion.

The council, responsible for deciding which non-bank financial firms are systemically important and require Fed oversight, plans to evaluate those that have $50 billion or more in assets and meet any one of five other criteria, including the credit-default swap threshold. Berkshire, AIG and MetLife all meet the asset minimum.

The swaps measurement is “forward-looking” and shows that “the market thinks you are big enough to bet on,” said Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics Inc., a bank consulting firm. “It also gives the regulators external, market-driven information about perceptions of credit risk.”

Berkshire Hathaway Chairman Warren Buffett tours the trading floor at the New York Stock Exchange Sept. 30. Berkshire may be designated a non-bank SIFI under a Financial Stability Oversight Council proposal. Photo: Scott Eells/Bloomberg Close

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Berkshire Hathaway Chairman Warren Buffett tours the trading floor at the New York Stock Exchange Sept. 30. Berkshire may be designated a non-bank SIFI under a Financial Stability Oversight Council proposal. Photo: Scott Eells/Bloomberg

Taxpayer Bailout

The provision measuring gross notional credit-default swaps wasn’t included in a previous proposal the council released in January. Credit-default swaps are a measure of a firm’s or country’s interconnectedness, or how one entity’s failure could bring down others. AIG, once the world’s largest insurer, received a taxpayer bailout in 2008 designed in part to protect banks that bought $62.1 billion in swaps from the firm. The market value of the securities tied to the derivatives collapsed, spurring collateral calls that drained AIG of cash.

The criteria provide insight into what the council, which is led by Treasury Secretary Timothy F. Geithner and includes Fed Chairman Ben S. Bernanke, will consider when deciding which firms are significant enough that their failure would pose a risk to the broader financial system. The panel said in its Oct. 11 proposal that the criteria would have “captured” Bear Stearns Cos., Lehman Brothers Holdings Inc. (LEHMQ), Countrywide Financial Corp. and IndyMac Bancorp Inc. (IDMCQ) had they been used during the 2008 crisis.

Buffett didn’t respond to a request for comment e-mailed to his assistant, Carrie Kizer. AIG spokesman Mark Herr declined to comment. Christopher Breslin, a spokesman for MetLife, said “it would be premature” to discuss the systemic-risk rules before they are complete.

MF Global

MF Global Holdings Ltd., the bankrupt futures brokerage, had $40.5 billion in assets as of March, placing it under the council’s $50 billion guideline. A year earlier, the firm’s assets totaled $51 billion. Jon Corzine, the former co-chief executive officer of Goldman Sachs Group Inc. (GS), quit Nov. 4 as New York-based MF Global’s chairman and CEO.

The company “would not have qualified” as systemically important under the council’s proposed rules, Bernanke said at a Nov. 2 press conference in Washington.

Firms with credit-default swaps written against them aren’t necessarily risky. Berkshire, for example, earns about $1 billion monthly from its businesses. The company increased its stock investments in the third quarter.

“It’s good risk management to hedge credit risk with a counterparty regardless of one’s expectation of risk,” Petrou said.

Living Wills

Designated firms can be ordered by the Fed to raise capital and reduce risky practices. The companies also would have to file “living wills” that spell out how they could be unwound in an orderly way to avoid destabilizing the wider financial system.

Lobby groups for hedge funds, insurers and securities firms concerned that Fed regulation would be burdensome and make them less profitable have urged the council to use caution in designating companies.

The other criteria the council, or FSOC, will consider are whether a company has a 15-to-1 leverage ratio, $3.5 billion in derivatives liabilities, $20 billion of outstanding loans borrowed and bonds issued, and a 10 percent ratio of short-term debt to assets. Treasury spokeswoman Colleen Murray declined to comment beyond the council’s proposal.

Face Value

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements. Data on the top 1,000 referenced entities for gross notional credit-default swaps have been published since November 2008 by the Depository Trust & Clearing Corp., though specific swaps information was available to regulators before then. DTCC, based in New York, is the biggest trade repository for over-the- counter derivatives.

“If there’s been a lot of credit-default swaps written referencing you, then someone’s worried about you, and that could be a reason for the council to have another look at you and see what’s going on,” said Darrell Duffie, a finance professor at Stanford University and a member of the Federal Reserve Bank of New York’s Financial Advisory Roundtable.

Buffett, 81, built Omaha, Nebraska-based Berkshire over four decades by acquiring businesses including insurer Geico Corp. and betting on stocks like Wells Fargo & Co. (WFC) The company produces power, makes candy, distributes cigarettes, brokers home sales and hauls freight across its 32,000-mile railroad network. Buffett, the CEO and head of investments, provided $5 billion of financing to Goldman Sachs at the depths of the 2008 credit crunch.

Earnings Report

Berkshire said Nov. 4 that third-quarter profit fell 24 percent to $2.28 billion as its derivative bets declined in value.

MetLife has said in regulatory filings since at least August 2010 that it may be named a systemically important financial institution, or SIFI.

“At this point no one knows exactly who will be designated non-bank SIFI, or, if you are designated, what the rules will be,” MetLife CEO Steven Kandarian said on an Oct. 28 conference call. “We are discussing this issue at length with people in Washington and we’re trying to make sure they understand the importance of a level regulatory field for our industry.”

The company is seeking to sell operations that gather deposits and make mortgage loans so that the insurer will no longer be regulated as a bank. MetLife said Oct. 25 that its plan to increase the dividend and resume share repurchases was rejected by the Fed.

Automatically Subject

Bank-holding companies with more than $50 billion in assets -- including Bank of America Corp. (BAC), JPMorgan Chase & Co. (JPM), Morgan Stanley (MS), Goldman Sachs, Wells Fargo and Citigroup Inc. (C) -- are automatically subject to heightened Fed supervision under the Dodd-Frank law. All of those banks have more than $60 billion in swaps written against them.

Geithner suggested in September 2010 that designated companies could include New York-based AIG and GE Capital, a unit of Fairfield, Connecticut-based General Electric Co. (GE) that benefited from a government backstop for financial-company debt.

GE Capital, with $95.8 billion of credit-default swaps tied to its debt, has been regulated by the Fed since July, Keith Sherin, GE’s chief financial officer, said on an Oct. 21 call with analysts. GE Capital had been supervised by the Office of Thrift Supervision, the now-closed regulator whose oversight has been moved to other agencies. The company has said it expects to be designated systemically important.

“It’s very early in the process of them getting to understand us, and we’re working constructively and transparently with them,” Sherin said of the Fed.

Analysis of Data

The swaps threshold was chosen based on an analysis of data for non-bank financial companies, the FSOC said in its proposal. If more than that amount is sold on a firm, it “indicates that a large number of institutions may be exposed” to the company and “may be affected” if it fails.

Firms that meet the criteria aren’t necessarily designated for Fed supervision, giving the council flexibility to use its judgment. The proposal is open to a 60-day public comment period ending Dec. 19 and can be changed.

The council will analyze the companies, then contact the firm in question to collect more information. Based on a review of the data, the FSOC may vote by a two-thirds majority to designate a company systemically important. The firm may request a hearing to contest the decision.

“One concern is that’s an element that is outside of the control of the non-bank financial company,” said Satish Kini, co-chair of Debevoise & Plimpton LLP’s banking group. “This was a surprise. I hadn’t seen it as an element previously.”

Sovereign nations lead the swaps list. Italy, with $306.6 billion written against it, is followed by Brazil, Spain, Turkey and France. Greece, with $74.4 billion, is ninth among countries.

To contact the reporters on this story: Ian Katz in Washington at Ikatz2@bloomberg.net; Cheyenne Hopkins at Chopkins19@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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