I used to have respect for Munger and Buffett, and I still do, but I am finding it harder and harder to think they have not lost touch with modern finance. Derivatives serve a legitimate purpose. I include credit default swaps and collateralized debt obligations in that statement.
Under the Big Bang and the SNAC rules, the regulators have managed to reign in the credit default swaps (CDS). Under Big Bang, credit default swaps are now primarily settled by means of an auction when a credit event occurs, a committee of both buy-side and sell-side institutions decide what constitutes a credit event, and we move toward a more standardized contract. These events are the precursor to a much larger centralized clearing system and exchange. CDSs also have so many legitimate uses, banning them would be a terrible idea. For instance, with credit default swaps, I can synthesize a collateralized debt obligation (CDO).
CDOs clean up balance sheets by moving assets into a special purpose vehicle (SPV), thus freeing up regulatory capital and lending capacity. This, in turn, means that by bringing this market back, we can get lending to a healthy level again. This would help to alleviate the job crisis we are now facing.
Both CDSs and CDOs have the capacity to reinvigorate the economy just as much as they had the ability to destroy the economy. We shouldn't be trying to ban these instruments all together, but instead we should be trying to figure out how they were abused, and clamp down on the practices that brought the world to a screeching halt.
I'm not making a statement about investment styles. You are confusing two related, albeit, very different terms: investment and finance.
My comment was purely one of a financial nature. These instruments allow risk to be transferred from one group to another group, to those less willing to accept risk to those more willing to accept risk. Let's assume that we have a bank whose corporate mission is only to deliver financing to the local community. This bank does not go out into the markets and speculate on the movements of different instruments. This bank can still use things like credit default swaps, CDOs, and other derivatives to transfer risk from itself to other parties more willing to accept it. In the process, the bank is able to help the community by creating loans and at the same time retain a risk-level that makes them feel comfortable. This has nothing to do with investing in the sense of what Munger and Buffett do with Berkshire or what numerous mutual funds, hedge funds, or other investment managers do on a daily basis.
Lost touch? didn't the make a hefty investment in Goldman?
Regulating this stuff is going to be a challenge, seems like some limits on leverage and risk are needed but there are always unintended consequences and the leverage and risk did provide a lot of liquidity.
The article is basically a damning of the entire credit derivatives market if not all of derivatives. The point I was trying to make is that these instruments serve a legitimate purpose, and I find it quite unnerving that two of the people most involved in the financial industry would come out in favor of greatly reducing, if not eliminating all together, the use of these instruments.
Yeah so the article is anti-derivatives but then Munger and Buffet (perhaps I shouldn't group them together but they are strongly connected) have taken a huge stake in Goldman which pretty much makes their money from derivatives. So far as I can tell, they aren't dismantling Goldman or making it fundamentally change in any way, it really just looks like they're after a cut of the next round of action.
