Buffeted by market forces

And I beheld when he had opened the sixth seal, and, lo, there was a great earthquake; and the sun became black as sackcloth of hair, and the moon became as blood;

And the stars of heaven fell unto the earth, even as a fig tree casteth her untimely figs, when she is shaken of a mighty wind.

And the heaven departed as a scroll when it is rolled together; and every mountain and island were moved out of their places.

And the kings of the earth, and the great men, and the rich men, and the chief captains, and the mighty men, and every bondman, and every free man, hid themselves in the dens and in the rocks of the mountains;

And said to the mountains and rocks, Fall on us, and hide us from the face of him that sitteth on the throne, and from the wrath of the Lamb:

For the great day of his wrath is come; and who shall be able to stand?

~Revelation, Chapter 6

Felix Salmon asks the unthinkable:  will Berkshire Hathaway lose its credit rating?  Yes, that's right:  Berkshire Hathaway, the Warren Buffet money machine, is in danger of being downgraded from AAA.  Surely, the hour of financial apocalypse is at hand:

Berkshire's market capitalization, at $139 billion, is still significantly higher than its book value, which was $118 billion as of June 30 and is surely significantly lower now, given the degree to which Buffett's investments in the likes of Goldman Sachs have eroded. In other words, the stock market is still pricing in growth and profits, even as the bond market is much more pessimistic.

All insurance companies have a certain amount of event risk. But for Berkshire Hathaway the event the company is most worried about isn't a hurricane or an earthquake -- it's a credit downgrade. Roger Ehrenberg asks the question on everybody's mind: "If the market continues to push against Berkshire's credit will a downgrade become a self-fulfilling prophecy?"

A downgrade could be very, very bad for Berkshire, depending on how its collateral agreements are worded. At some point, Berkshire's counterparties are going to be able to ask it to put up a lot of collateral against the derivatives contracts it has written -- not only the CDS contracts, mind, but quite possibly also the long-dated put options it's written on broad stock-market indices. Such collateral calls could be extremely harmful to Berkshire's business model -- and that's before taking into account the loss of business at its new monoline subsidiary.

A lot of wonks, undoubtedly ably abetted by NPR, have focused on the CDS market as the source, rather than the sign, of problems.  But the CDS market has not, as far as I can tell, caused many problems in and of itself.  AIG's problem wasn't some tricky issue with the CDS market; it was a ratings downgrade that forced them to put up more reserves.  Berkshire Hathaway faces the same potential issue.

To be sure, the regulatory arbitrage in the CDS market has allowed firms to essentially write insurance with inadequate reserves, which is a problem that should be corrected.  On the other hand, insurance companies do fail when their portfolios crash, even with "adequate" reserves.  RIght now previously safe-as-houses securities have suddenly become, well, as risky as houses.  And when that happens, the government ends up covering the loss, whether we describe it as bond insurance or a CDS.

But what we haven't seen, until now, as far as I can tell, is the kind of problems we've had in the CDO market, where contagion from massive changes in risk appetite seems able to bring down entirely solvent investors.  What Salmon's post suggests is that this is changing; that worries about Berkshire Hathaway's credit rating are, to coin a phrase, being the change we don't desire.