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The Snake-Oil Oracle of Omaha?


Warren Buffett's days as a deity may be numbered.

In his recent letter, Warren Buffett defends the trade that many believe made him a hypocrite. While his explanation has some merit -- would we expect anything less from the Oracle? -- it ultimately falls way, way short.

Mr. Buffett famously has called derivatives "financial instruments of mass destruction" - but it hasn't stopped him from using them rather extensively.

In fact, let's really think about this. Mr. Buffett's core business is insurance. An insurance contract is nothing if not a derivative. Its payoff is based -- derived, as in derivatives -- from the value of something else.

Insurance on your life pays off if you die, an event that zeroes out your future earnings stream. Insurance on your house pays off if the house burns down, destroying the home's ability to provide shelter and generate rental income. Business-interruption insurance pays off if something beyond your control forces you to close your store, reducing its cash flows.

From this perspective alone, I would argue that someone living in the ultimate glass house of derivatives should be more careful about throwing stones.

But it gets worse. Mr. Buffett has sold billions of dollars worth of derivatives -- puts, to be precise -- on major stock indices. He has also sold the dreaded credit default swaps on indices and individual companies.

In his letter, Mr. Buffett seems to acknowledge that the CDS sales aren't going so well. "Whatever the result, I will keep you posted," he writes. How very kind of the chairman of a public company to report to his shareholders on the results of the business.
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