<i>"Worst case for Buffett is he pays cash to own the S&P in 2019 at 1998 or lower levels. Hardly a disaster."</i> This is the opposite of Vic N. selling puts at all-time market highs when it feels right but is totally wrong. Ten years from now, are the chances of major indexes greater to be lower than, where they are, or higher than strike price levels of those puts? Equal to or higher than = net profit. Even slightly lower than strike prices could be profitable and/or would be breakeven. Ten years is one helluva long time. Anyone who opts to sell premium as a strategy should take notes on this one. It is a textbook perfect bet under those parameters.
New York state officials have begun examining middlemen in the market for credit-default swaps, as they comb for potential evidence of manipulation in the largely unregulated world of CDS trading. The latest focus of regulators' inquiry are firms known as interdealer brokers, or the generally small, independent shops that serve as matchmakers for Wall Street firms trading in credit-default swaps, bonds and other instruments. Interdealer brokers, which typically promise to keep banks' positions secret from rivals, are at the nexus of the Wall Street information flow, with unique insight into the trading activities of their clients. The office of New York state's attorney general, Andrew Cuomo, recently subpoenaed trading data and other communications from eight of these interdealer brokers. The Securities and Exchange Commission also is conducting separate inquiries into the market. Officials are looking for market players who, during August and September, may have spread false information to manipulate CDS prices, say the people familiar with the investigation. CDS prices have recently had strong influence over stock and bond prices of financial firms such as Morgan Stanley and American International Group Inc. The regulators are examining how interdealer brokers also may have participated in or were used in any possible manipulation. Lacking any central regulator or industrywide rules, the CDS market has long had a freewheeling culture, where information is swapped in offhand remarks in instant-message chats. "The interdealer brokers appear to be overseen by no one and governed by loose standards and gentlemen's agreements," said one person involved in the New York attorney general's investigation. Credit-default swaps are insurance-like contracts in which a buyer makes regular payments to a seller, who in turn agrees to make a payout if a company defaults or files for bankruptcy protection. CDS interdealer brokers, which earn fees from every trade they facilitate, have prospered during the past decade as the market for a once-obscure insurance mechanism grew to a $33 trillion bazaar. This market has been largely opaque to both regulators and the public, becoming a source of growing agitation because the CDS market is viewed as a systemic risk to the global financial system. "Everything is supposed to be anonymous before the deal is done," said Howard Lutnick, chief executive of Cantor Fitzgerald, which owns an interest in interdealer broker BGC. Mr. Lutnick said his brokerage customers want anonymity. If they didn't want that secrecy, they wouldn't trade through brokers. One of the only windows into the behavior of CDS interdealer brokers comes via a 2007 lawsuit filed by brokerage firm IDX Capital LLC against brokerage Phoenix Partners Group LLC. The lawsuit filed in New York state court alleges that Phoenix interfered with a deal to sell IDX to another trading firm. The suit includes several hundred pages of internal documents, including transcripts of instant-message conversations between Phoenix founders and clients. Dating to 2004, the messages hail from when some Phoenix executives ran a company called Axiom Global Partners and aren't related to the matters that have recently come under investigation. The messages depict aspects of the CDS trading culture, with brokers commonly passing private information about other firms' intentions and positions ahead of trades. In other markets, such as those for stocks and bonds, the Financial Industry Regulatory Authority has interpreted its securities rules to mean that brokers can't divulge or use customer information in a way that compromises their orders or trades. In the realm of CDS trading, the standards are less clear because the swaps aren't defined as securities, but rather as private contracts, say industry players. In August, 2004, for instance, current Phoenix partner Marcos Brodsky sent J.P. Morgan Chase & Co. credit-derivatives trader Roman Shukhman an electronic message informing him of what other clients were interested in buying, according to court documents. Mr. Brodsky wrote the message using broker slang: "hvol offer is gs fyi." It conveyed that Goldman Sachs appeared to be looking to sell a position in a credit-default-swap index called "hvol." Mr. Brodsky then indicated that Lehman Brothers was interested in Goldman's offer. "Leh checkin," wrote Mr. Brodsky. Mr. Brodsky adds later that, "leh now sayin the[y] don't care." In a separate exchange from July 2004, Mr. Shukhman wrote to Mr. Brodsky, "I want to know when simpson is on the other side," referring to finding out when a Deutsche Bank AG trader named Matt Simpson was in the market . "Fo shiz," wrote Mr. Brodsky, using slang for "for sure." "Counterparty risk has been a fundamental concern in the credit derivatives market since its inception," said a spokesman for Mr. Brodsky. "With no central clearing mechanism to address this issue, traders often demand to know who is on the other side of a transaction in advance of a trade. Anyone who suggests that there is anything untoward about requesting or providing such disclosure, especially given current market conditions, doesn't understand the realities and complexities of the credit derivatives market or has an underlying agenda." J.P. Morgan declined to make Mr. Shukhman available for comment. Deutsche Bank declined to make Mr. Simpson available. Disclosing information about clients' identities before a trade is, in some cases, considered unethical by other brokers, traders and regulators. Knowledge that a competitor is trying to amass a position could be used to bargain for better pricing on a trade or to undercut other traders' positions. Consider a $500 million position in an index of credit-default-swaps contracts. A move of 0.01 percentage point, or one "basis point," typically can amount to a $460 gain or loss per $1 million traded. If an index moves 0.20 percentage point -- as it can on especially volatile days -- a trader's book could swing by $4.5 million. Yet the opaque trading environment has made it easier for Wall Street banks to mark up prices charged to outside buyers, which in turn has made CDS trading a huge profit center for the banks. In all, CDS trading amounts to 15% to 25% of top Wall Street firms' trading revenues, estimates CreditSights analyst David Hendler. In the first two quarters of 2007, when trading revenues were at their peak, Mr. Hendler estimates J.P. Morgan could have cleared $1 billion to $1.9 billion from CDS sales and trading. For Goldman Sachs, that would mean $2 billion to $3.4 billion, said Mr. Hendler. The attorney general's subpoenas include Phoenix Partners Group, ICAP PLC, GFI Group Inc., IDX Capital, Tullett Prebon PLC, BGC Partners Inc., Creditex Group Inc. and Standard Credit Securities Inc. according to a person close to the probe. These firms declined to comment. Write to Liz Rappaport at liz.rappaport@wsj.com and Serena Ng at serena.ng@wsj.co
NEW YORK, Nov 21 (Reuters) - Warren Buffett's Berkshire Hathaway Inc (BRKa.N: Quote, Profile, Research, Stock Buzz) (BRKb.N: Quote, Profile, Research, Stock Buzz) provided details to the U.S. Securities and Exchange Commission on how it values what has so far been a money-losing $37.04 billion derivatives bet, after the regulator asked for better disclosure. The SEC completed its review on Oct. 7 without further comment, four days after Berkshire said it did not need to buy equities that underlie its derivative contracts. On June 4, the SEC had demanded "a more robust disclosure" of factors that Berkshire used to value the contracts. The SEC released correspondence between Berkshire and the regulator on Friday, two weeks after Berkshire said more than $1 billion of losses on derivatives led to a 77 percent overall profit decline at the Omaha, Nebraska-based company. Buffett's derivatives bet has faced much scrutiny from analysts and investors this year. They have led to paper losses for Berkshire, and Buffett, perhaps the world's most admired investor, has previously called derivatives "financial weapons of mass destruction." Berkshire's derivatives could require the company to pay up to $37.04 billion between 2019 and 2027 if the Standard & Poor's 500 index .SPX and three other stock indexes were lower than when Berkshire entered the contracts. The company obtained about $4.85 billion of premiums upfront, which Buffett may invest as he wishes. Buffett has said he expects the contracts to be profitable. But falling equity values had by Sept. 30 forced Berkshire to write down $6.73 billion on the contracts. Losses have almost certainly mounted since then as stocks worldwide tumble. On July 3, the newly released correspondence shows, Berkshire Chief Financial Officer Marc Hamburg told the SEC that the company's model to value the contracts was based on such factors as equity prices, interest rates, dividend payouts and currency fluctuations. "Berkshire believes the two most significant economic risks relate to changes in equity prices and foreign currency exchange rates," Hamburg wrote. Hamburg also told the SEC that Berkshire's nearly 20 percent stake in Moody's Corp (MCO.N: Quote, Profile, Research, Stock Buzz) did not mean Berkshire could "control or significantly influence" activities at the parent of credit rating agency Moody's Investors Service. Connecticut Attorney General Richard Blumenthal in May said he was examining the potential for conflicts of interest arising from Berkshire's stake in Moody's and its operation of a bond insurance unit, Berkshire Hathaway Assurance Corp. In a separate development on Friday, USG Corp (USG.N: Quote, Profile, Research, Stock Buzz) said Berkshire agreed to buy $300 million of convertible senior notes yielding 10 percent from the building materials supplier. USG also sold $100 million of the notes to Canada's Fairfax Financial Holdings Ltd (FFH.TO: Quote, Profile, Research, Stock Buzz). Berkshire owns a 17.2 percent stake in USG. Shares of USG rose as much as 30.7 percent on Friday. Berkshire Class A shares rose $3,000 to $80,500 in late afternoon trading on the New York Stock Exchange. Their record high is $151,650 set last Dec. 11. (Reporting by Jonathan Stempel; Editing by Gary Hill)