Deconstructing Drivel on Derivatives

If you were to draw a thread through the business articles in last week’s New Yorker, you would think that business is full of toy-loving, outsider psychopaths who dabble in deconstructionism.

That last point about deconstructionism I find offensive.  (The rest is probably true.)

In the article likening derivatives to deconstructionism, Lanchester doesn’t do enough to differentiate between simple derivatives (e.g., “I’ll buy 100 pounds of wheat for $1 a pound next June:”) and complex derivatives (e.g., the dreaded Credit Default Swaps.)

His point person in all of this is Warren Buffet.  Lanchester claims, “Buffett dislikes derivatives.” He supports that with two quotes, like this:

The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen). At Enron, for example, newsprint and broadband derivatives, due to be settled many years in the future, were put on the books. Or say you want to write a contract speculating on the number of twins to be born in Nebraska in 2020. No problem—at a price, you will easily find an obliging counterparty.

The second:

No matter how financially sophisticated you are, you can’t possibly learn from reading the disclosure documents of a derivatives-intensive company what risks lurk in its positions. Indeed, the more you know about derivatives, the less you will feel you can learn from the disclosures normally proffered you. In Darwin’s words, “Ignorance more frequently begets confidence than does knowledge.”

What Buffet is railing against here is a COMPLEX derivative.  But a simple Google search shows that, Buffet’s company Berkshire Hathaway holds, you guessed it, DERIVATIVES.  Let me say that again:  Buffet manages derivatives. From page 16 of their 2007 annual report:

Last year I told you that Berkshire had 62 derivative contracts that I manage. (We also have a few left in the General Re runoff book.) Today, we have 94 of these [ . . .  ].

This is what happens when The New Yorker allows people to over-articulate business issues.  So while both Deriddian deconstructionism and complex derivatives are bad, conflating the two is a bit of pompous cocktail chatter.