Warren Buffett MBA Talk video 1 hr 28 min

Echoing his previous characterization of derivatives as " financial weapons of mass destruction," Warren Buffett, in his testimony before the Financial Crisis Inquiry Commission, expressed concern about the risk to major banks such as Morgan Stanley due to excessive use of derivatives. He also discussed the failings of securities rating agencies and the dangers of too much leverage.

Buffett's contrasted the massive use of derivatives to a "couple of guys rolling the dice for $5 a throw." He said "If I look at JP Morgan, I see two trillion in receivables, two trillion in payhables, a trillion and seven netted off on each side and $300 billion remaining, maybe $200 billion collateralized...that's all fine. But I don't know what discontinuities are going to do to those numbers overnight if there's a major nuclear, chemical or biological terrorist action that really is disruptive to the whole financial system...Who the hell knows what happens to those numbers? I think it's virtually unmanageable." [Within the past week the earthquake and sunami in Japan may provide a test for markets in general and firms that are loaded with derivatives in particular. U.S. stocks dropped deep into the red Tuesday, joining a global market selloff that started in Tokyo as Japan's nuclear crisis deepened and worries escalated over the human and economic toll of last week's devastating earthquake. 3-15--The Dow Jones Industrial Average dived 285 points, or 2.4%, to 11703, while the Standard & Poor's 500-stock index shed 35 points, or 2.7%, to 1261. The Nasdaq Composite tumbled 77 points, or 2.9%, to 2623.]

The sharp selloff came after news of two more explosions at Japan's Fukushima Daiichi nuclear-power plant, releasing large amounts of nuclear material directly into the atmosphere. Prime Minister Naoto Kan warned of "substantial" radiation leaks. Tokyo also suffered an aftershock in the late evening, according to Dow Jones Newswires.]

Buffett also raised the issue of companies who use derivatives to smooth earnings , for example, Coca Cola which employs the instruments to protect against currency fluctuations in the many countries where the company does business or Burlingthon Northern which has used derivative contracts to protect against fuel cost fluctuations. He said, according to a report in the New York Times, "And I'm not saying there's anything wrong with that, but that's the motivation...I wouldn't do it."

A transcript of Buffett's testimony is linked below. Also linked below is a transcript of David Einhorn's testimony before the Commission in which he explains how he foresaw the subprime mortgage melt down. Both transcripts are worth reading in their entirety.