Taxpayers should wake up the politicians and ask them to tell Wall Street: “We want the same deal Warren Buffett got.” The Omaha billionaire announced he is playing White Knight to Goldman Sachs by investing $5 billion in the endangered investment house. What a big-hearted guy. Buffett is an old-fashioned capitalist who invests in companies for the long term and I am a big admirer. But Warren Buffett did not get to be a billionaire by committing public-spirited acts of charity. He plays to win.
So his deal with Goldman Sachs is carefully wired to produce gorgeous returns for Buffett’s Berkshire Hathaway. Upfront, he gets a 10 percent ownership stake in preferential shares that will pay a 10 percent dividend–even if Goldman’s stock price keeps falling. But Buffett also gets the right to buy $5 billion in common shares at below the market price. So if Goldman flourishes in these hard times, Buffett will win big as its stock price soars.
To sweeten his chances, the Omaha sage quickly announced that he endorses the $700 billion bailout plan proposed by Treasury Secretary Paulson. Let’s follow the bouncing ball. Buffett puts some of his capital at risk on terms that are smartly protected from loss. Then Buffett urges the taxpayers to put their money on the line too. Only the taxpayers don’t have any deal. They are the naked investors in this drama, asked to put up many billions to rescue Wall Street firms with nothing more than a vague promise it will save the Republic. I am reminded of the oldest rule in the financial business: “Get it in writing.”
Warren Buffett’s intervention provides a clarifying moment because it demonstrates what’s wrong with the bipartisan bailout Congress is preparing to authorize. There’s nothing illegitimate in what Buffett accomplished. The overlapping terms and contingencies he secured for his capital are standard practice in Wall Street deal-making. Investment bankers work out the fine print and put it in enforceable contracts or the deal doesn’t happen.
Hank Paulson was a star in that world. When he left as chief executive to become Treasury Secretary in 2006, Goldman awarded him $110 million in cash to cover remaining stock options and restricted stock, in addition to $51 million to repurchase family shares. These payments were on top of the approximately $500 million in Goldman shares Paulson sold when he joined the government.
Doing hard-nosed deals in the Buffett style is essentially what the federal government should be doing now–bank by bank–as it intervenes to rescue the financial system from ruin. In our situation, the public treasury is the White Knight because private capital is afraid to play. The federal government has all the leverage it needs to demand very stern terms. That includes demanding an equivalent equity stake in banks or brokerages it assists, but also the power to impose explicit commandments and prohibitions on how these rescued firms must behave. The threat that banks will refuse to play is a meaningless whine from the banking industry. If bankers find a better deal from private lenders, they should take it. Otherwise, they are down the tubes.
The underlying power relationship in this crisis has been artfully obscured by the bailout sponsors because they decline to explain clearly what the bailout really is intended to accomplish. First, they said it was to restore calm in markets. Then they said it was the rotten assets centered in mortgage securities. But the problem is more accurately described as the great deflation of Wall Street’s illusions–inflated prices, profits, deals, commissions and bonuses. You name it, they ran it up to stratospheric levels. Now the dream is dying and values are falling, but have not yet hit bottom.