Warren Buffett's Opinion on the Derivatives Market

There are several forms of derivatives markets, all of which only can be triumphed by the most savvy and insightful teams of investors. Comprised of futures, forwards, options, and various other even more complex derivatives, the contents of these markets are not only thought of as tremendously risky investments, they are considered to have an extremely high potential for economic destruction. The derivatives market, with a notional value of upwards of 1.4 quadrillion dollars, is forty times the worth of the world’s stock markets combined and twenty-three times the worth of the world’s GDP, just to put it into perspective.[7] What is really frightening is the fact that it is simply a very large collection of ‘side bets’ that investors take, each investment being ‘derived’ from the upward or downward price movement of an underlying asset. Investors are only betting on price movements; they do not purchase a tangible asset as a result, these are only contracts based on only the investor’s speculations. To top it off, this market is completely unregulated, and derivative securities consequently are recognized as the cause of the financial collapse in 2008.[7] Why is the exposure for demon-like investments like these so high, especially if they are what caused the financial crisis in 2008? It is because Wall-Street makes 35 billion dollars a year trading them, and those in charge of economic policy in America threatened that markets would implode if derivatives moved toward regulation.[7]

Referred to as the Oracle of Omaha, Warren Buffett, said to be the greatest investor in the history of the world,[4] has never been shy expressing his opinion on the “hell” that is the derivatives market.[1] This opinion could be the result of his poor derivatives investment after Buffett and his company, Berkshire Hathaway, purchased General Reinsurance Securities, one which forced him to unwind 23,000 derivatives contracts, and resulted in a loss of $400 million dollars.[6] Considering this loss or not, Buffett, in regards to his stance on the derivatives markets, is commonly referenced stating that “derivatives are financial weapons of mass destruction.”[1] Keep in mind this was stated long before credit default swaps, a derivative investment, wreaked havoc on the economy in the form of the financial crisis in 2008.

His comment is justified due to the tremendous exposure that the derivatives market has on the financial system: “The problems arise when a bank’s exposure to derivatives balloons to grand proportions and uninformed investors start using them.” He goes on to ask what happens then “if there’s a major nuclear, chemical or biological terrorist action that really is disruptive to the whole financial system.” Due to the tremendous size of the derivatives market, the numbers, contracts, and dollars affected would be “virtually unmanageable.”[6] Buffett very clearly had negative connotations of the derivatives