Financial Weapons of Mass Destruction

Credit Default Swaps Are a Valuable Invention, But Largely Unregulated

By Charles R. Morris 06/10/2008 | 1 Comment

Warren Buffet calls credit derivatives "financial weapons of mass destruction." When his company, Berkshire-Hathaway, Inc., took over an insurance company in 2002, it took him four years to unwind its portfolio of credit derivatives -- at a cost of $400 million. Buffet didn’t entirely follow his own advice, however, because in the first quarter this year Berkshire-Hathaway took another $500 million loss on credit derivatives.

Why worry about credit derivatives? One reason is that the "notional value" of the most important credit derivatives, credit default swaps, or CDS, is now $62 trillion. That’s trillion, with a "‘T," and it is more than the whole world’s gross domestic product. Numbers that big automatically make people nervous, especially when they see the canniest investors like Buffet taking losses.