Buffett’s Payouts Climb on Credit Derivatives After Defaults [Excerpt]
Bloomberg News – August 11, 2009
By Shannon D. Harrington

At one point in 2005, Berkshire had been paid an average of 75 percent of the maximum loss upfront to take on such risk, according to Janet Tavakoli, founder of Tavakoli Structured Finance Inc. in Chicago, who wrote about Buffett’s credit swaps trades in her 2009 book “Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street.”

Recovery Rates

Holders of debt issued by non-financial companies recovered an average of 45 percent during the past two recessions, according to Moody’s Investors Service. That means Buffett in 2005 was getting paid an average 75 cents on the dollar to back bonds that, if they defaulted, typically lost 55 cents on the dollar during the last two slumps. [JT Note: This is not true. Recovery rates for high yield debt, and even investment grade debt, are variable. Part of the problem with rating agencies’ methodologies is the use of average recovery rates. Default probabilities and recovery rates are specific to individual names. If you build in a margin of safety, you cannot rely on rating agencies’ average data, and you can never rely on their ratings. To the best of my knowledge, Berkshire Hathaway does not rely on ratings, including Moody’s ratings.]

“People say he doesn’t understand derivatives,” Tavakoli said in an interview before the second-quarter results were announced. “He very much does know what he’s doing, but you have to be aware in any investment, the best you can do is build in a margin of safety.”

End of Excerpt


Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct professor of derivatives at the University of Chicago's Graduate School of Business. She is the author of: Credit Derivatives & Synthetic Structures (John Wiley & Sons, 1998, 2001), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, 2008).

Janet Tavakoli's book on the causes of the global financial meltdown (and how to fix it) is Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (John Wiley & Sons January 2009).

Clients of Tavakoli Structured Finance have the benefit of proprietary research, which is not available in any other paid or public forum. Clients also commission proprietary research and analysis.

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