Buffett defends using derivatives at Berkshire

By Jonathan Stempel

NEW YORK (Reuters) - Saying "derivatives are dangerous," Warren Buffett defended his use of them after they played the main role in driving Berkshire Hathaway Inc (BRKa.N)(BRKb.N) annual profit to a six-year low.

Buffett devoted one-fifth of his 21-page annual letter to Berkshire shareholders to explaining how he uses derivatives to make long-term bets on stock markets, corporate credit and other factors.

"It's part of a portfolio of risk assumption that people appreciate in capital markets, and helps cement relationships that lead to more business for Berkshire down the road," said Bill Bergman, senior equity analyst for Morningstar Inc in Chicago and a former Federal Reserve economist.

As regulators had requested, Buffett provided far more detail on the 251 derivatives contracts that Berkshire has, which the company said in theory could require $67.29 billion (47.36 billion pounds) of payouts in the event every bet went 100 percent wrong.

He also said investors should distinguish Berkshire's derivatives from others that dramatically increased financial leverage, made banks "almost impossible for investors to understand," and threatened the collapse of financial services companies such as investment bank Bear Stearns Cos and mortgage financiers Fannie Mae (FNM.P) and Freddie Mac (FRE.P).

"I believe each contract we own was mispriced at inception, sometimes dramatically so," he said. "I both initiated these positions and monitor them, a set of responsibilities consistent with my belief that the CEO of any large financial organization must be the chief risk officer as well. If we lose money on our derivatives, it will be my fault."

Berkshire had $4.65 billion of net investment and derivative losses in 2008. Overall profit for the Omaha, Nebraska-based company fell 62 percent to $4.99 billion.

But Buffett believes Berkshire's derivatives differs from others that constitute "financial weapons of mass destruction," in part because of the billions of dollars of premiums that he collects upfront from counterparties.