Why did Warren Buffett call derivates, "financial weapons of mass destruction?" Have you ever wondered that?

But first of all what is a derivative?

There are two types of assets in the world: Real assets like gold, silver, copper, food producing land, corn. Things that have intrinsic worth...And then there are derivative assets, i.e. things whose worth is derived from something else. An example would be an IOU. The IOU has no intrinsic value. It's only worth what someone else will give you for it, perhaps gold or silver, but oftentimes, another derivative, like the currency of Zimbabwe or the currency of the Confederate States of America.

This is the most basic definition of derivates. Usually in the popular press, however, the "derivatives" that are being referred to are basically mini insurance policies, paper assets that derive their value from other paper assets. This is what an insurance policy is. It has value because enough people are paying premiums to cover the cost of that 1 in 10,000 whose house mysteriously burns to the ground.

I once asked my father, who was an insurance man for most of his life, "What happens if everyone's house burns down at the same time?" The answer: "Then the insurance company goes out of business." That means that nobody gets anything.

So back to the question of why Warren Buffett, arguably one of the most sophisitcated economic thinkers of our or perhaps any time in history, would make such a statement?

For those of you who don't know. Mr. Buffett has made a large part of his fortune in the Insurance business, so he understands insurance and how it works or will stop working.

The answer to the question as to why he is so worried about derivateives: I would have to say that I really just don't know. BUT, I also don't know how Mr. Buffett knows or does most of the things he does. This, however, does not preclude me from respecting his amazing abilites.

Interestingly enough, just because someone suspected Saddam Hussein of having "weapons of mass destruction" the United States of America declared war. So "weapons of mass destruction" must be a pretty big deal. I wonder why someone like Mr. Buffett, who is notoriously conservative in his investments, known for not promoting "risky" points of view and is very clever at crafting the phrases he writes and speaks would make such a statement.

I am wondering if he sees something that we don't.

Those of you who have studied Mr. Buffett know of his nearly legendary mathematical mind. He has been known to quickly calculate probabilities in his head that most other mortals would need more sophisticated machinery to discern.

Is there a chance that we are really in for it, that the whole economy could just collapse?

Yes.

Consider yourselves warned. Bull