The share price of Warren Bufffett's investment vehicle / conglomerate Berkshire Hathaway came under severe pressure last week due to reports that it sold a large amount of put options on various stock indices. This week the shares bounced somewhat when a bunch of pundits declared the move completely unwarranted. However, it might be too early to breathe a sigh of relief as the problem with Berkshire's short put positions is the same that felled LTCM and many others: path dependency.

While it is unlikely that the stock markets in 10 or 20 years time will be below the levels of the put strike prices (although the FTSE is currently at roughly the levels it was at in 1988!) if the markets were to tumble another 20% or more then the ratings agencies might decide that Berkshire's AAA rating is no longer warranted. In fact, the CDS market has already de facto lowered Berkshire's rating way below this most august of investment grades some time ago. Any such downgrade could trigger clauses requiring Berkshire to post collateral to cover any mark-to-market losses. If at that point in time Berkshire needed to liquidate some holdings in order to raise the money (again unlikely given its cash hoard) then they would be selling into a falling market, possibly triggering further liquidation sales, and so on and so forth in a vicious spiral.

While this is an unlikely scenario, nobody last year would have dreamt that Lehman, Merrill and Bear Stearns would now be toast, with GS and MS having opted for the quiet life of a comercial bank.

The consequences of Berkshire getting into serious trouble would devastating: it would be like telling all market participants that there is no Santa Claus and that the Tooth Fairy does not exist.