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Buffett Says Derivatives ‘Time Bomb’ May Elude Auditors' Reviews

  • Concentrated derivative bets are a `time bomb,' he warns
  • Berkshire invested in BofA, Wells Fargo but avoids most banks

Warren Buffett said banks’ holdings of derivatives make it unattractive to invest in most large financial firms and that the contracts still contain hidden risks.

“Some of these things get so complicated that they’re very hard to evaluate,” Buffett said Saturday during the annual meeting of his Berkshire Hathaway Inc. in Omaha, Nebraska. “They can be extraordinarily hard to mark,” he said. “The auditors, I don’t think, are necessarily capable of holding that behavior in check.”

The remarks build on the billionaire’s critique of derivatives, even after Berkshire entered such contracts to speculate on stock movements or borrowers’ creditworthiness. Buffett said Saturday he shuns deals that could require Berkshire to post collateral, and that the larger risk is that a disruption to markets -- potentially from a cyber or nuclear attack -- could make it hard for the largest lenders to value their holdings.

“It’s still a potential time bomb in the system,” Buffett said. “Anything where discontinuities can exist can be real poison in markets.”

‘Enormous Gaps’

During the 2008 financial crisis, American International Group Inc. wasn’t able to meet obligations to banks after mortgage-related securities plunged in value, forcing the government to step in with a bailout. While regulators have worked to the limit risk that a single company’s blunders could infect the larger financial system, Buffett said there is still reason to be concerned about individual companies.

“If you take the 50 largest banks in the world, we wouldn’t even think about probably 45 of them,” Buffett said. “There can be enormous gaps in things that you thought were fully protected by collateral, or netting arrangements and that sort of thing. So I regard very large derivative positions as dangerous.”

Berkshire is the largest investor in Wells Fargo & Co., which is known more for retail deposits and mortgage lending than investment banking. Buffett said he’s not worried about that holding or a smaller investment in Bank of America Corp.

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