It's hard not to appreciate the symmetry of today's events.
Less than a week ago, Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke met with Congressional leaders and painted such a bleak picture of our financial system that they compelled the legislators into action, signaling initial support for a $700 blank check mechanism meant to overpower all the fear, uncertainty and doubt freezing up the liquidity of our capital markets. For good measure, SEC Chairman Cox piled on an ill conceived ban on select short sales.
The impact on the equity markets was short-lived, to say the least, as was the pledge of bipartisan support for getting something done in a timely fashion. As we braced for today's hearings, the equity markets staged a powerful sell off yesterday and many began to question the Paulson plan from seemingly every angle.
Having watched much of the hearings today, I was absolutely stunned at how unconvincing Paulson and Bernanke were in conveying their message of financial Armageddon to the Congressional committee. Let's hearken back to comments made by Senators Dodds and Schumer following last week's late night emergency session:
Congressional Leaders Stunned by Warnings [NY Times]
“When you listened to him describe it you gulped," said Senator Charles E. Schumer, Democrat of New York.
As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”
Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”
When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”
For those of you who listened to the hearings today, you heard those very same Senators (and their fellow committee members) paint a decidedly different picture. Where was the sense of urgency? Where was the "something must be done right now, and it's not about partisan politics" mantra?
More importantly, where was the eloquent, descriptive state of the financial union that so many of us expected to hear from Paulson and Bernanke today?
Today, Bernanke and Paulson HAD to be better than they were. Realistically, these men were asking for a $700 billion bail out package with a broad, sweeping expansion of their powers and had, to date, offered up a 3-page (or 6-page in the revised version) memorandum in defense of the maneuver. They needed to scare the American people with the severity of the realities facing them.
They had to know that the American people had spoken loud and clear to their elected officials in the preceding days. "Main Street" just wasn't seeing how the Paulson Plan helped them. And in an election year, particularly September of said election year, if you can't get "Main Street" to see the validity of the proposal you have ABSOLUTELY NO HOPE of getting Congress to sign on the dotted line. But didn't Bernanke and Paulson know that before sitting down to testify today?
I assumed they did. Which means either they a) simply failed on the grandest of public stages to convey the actual severity of the situation or b) made a calculated bet against coming across as the heavies to the American people; knowing that a significantly reduced version of the bail out plan was a best case scenario to begin with.
The Markets Didn't Seem to Put Much Faith in the Paulson Plan
The U.S. indices finished at the lows of the day today, following a dramatic sell off on Monday; signaling to many that investors simply weren't putting much credence in the state of the Paulson Plan to stem the bleeding in a timely and optimal manner.
Enter the Berkshire Call Option: Buffett Announces Investment in Goldman Sachs
Berkshire Hathaway has agreed to invest in Goldman Sachs, Buffett's first investment in a Wall Street firm since his much ballyhooed involvement with Salomon Brothers in the early 90s. The terms of today's agreement:
- Berkshire will invest $5B in exchange for perpetual preferred stock that pays a 10% annual dividend
- Berkshire will receive rights to purchase an additional $5B in common stock at $115 per share, exercisable for the next 5 years
- Goldman will raise an additional $2.5B in common stock through a secondary [it's first equity issuance since 2000]
- Goldman can call in the preferred stock at any time for a 10% premium
The Perceived Value of Buffett's Endorsement
As I type this, shares of GS are trading at $134.75 [up 7.9% after hours]; signaling the market's enthusiasm for Buffett's investment. Broadly, equity futures are up on this news. There are plenty of rational reasons for the market's enthusiasm tonight:
- Buffett is, without question, one of the best investors walking the Earth
- He's heretofore avoided stepping into the Wall Street malaise; his willingness now will be perceived as a signal of bottoming
- A lot of investors are more than happy to follow Buffett's lead
- This move puts Goldman on sounder financial footing and signals that the government's moves last week to stem the fire sale are working
- We're collectively (and justifiably) more impressed by the actions of a private free market participant than we are by the bazooka of forced socialism
But Let's Not Confuse Buffett's Investment in Goldman with What the Paulson Plan is Trying to Solve
The market is beaten up. Conviction is low. Volatility is (relatively) high. Buffett will make people feel better. Whether it's a temporary tonic or the siphon that gets the investment pump churning again very much remains to be seen. But I remain skeptical of this move as a harbinger of a broader fix for several reasons.
- This is a move to invest in a storied financial entity, Buffett's investment does NOTHING to help set a fair market price for the toxic assets the Treasury is trying to get $700B to acquire
- Buffett is just the latest investor willing to invest in a Wall Street firm under attractive terms; he's not blazing the trail here. For example, it was announced just a day ago that Mitsubishi UFJ is buying 20% of Morgan Stanley
- Buffett is getting extremely attractive terms; Goldman didn't provide Buffett with a $500mm annual dividend in perpetuity plus call options for 7% of the company's equity because it had offers pouring in. Few firms will be able to ask for, and get, those kinds of terms
It's not about this investment, it's about whether Buffett can convince the market of reasonable marks for all the toxic assets in the system. The market is tired and frustrated. A lot of people have been looking for "the sign" of a bottom in the financial sector and whether this helps spark the private sector to put money to work remains to be seen. One would hope that Buffett's willingness to get involved will also signal his willingness to actively vocalize thoughts on the appropriate way to value and dispose of the toxic assets which plague the system. If he can convince private buyers to start taking troubled assets off the banks' balance sheets, he may actually accomplish more with $5B than Paulson and Bernanke can with $700B. A scary thought to be sure, but one that's not out of the realm of possibility.
Disclaimer: At the time of writing, neither the author nor the firms affiliated with the author maintained an position, long or short, in the publicly traded companies mentioned or any related instruments. The author and the firm reserve the right to alter their investment positions at any time in the future. The content on this site is provided as general information only and should not be taken as investment advice. Content should not serve in any way as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of firms affiliated with the author. Any action taken as a result of information or analysis on this blog is ultimately your responsibility. Consult your investment adviser before making any investment decisions.
John,
Glad to be back. And yes, I would say the implied value on the options is at least $50, upwards of $55 plus the perpetual 10% divvy. As you said, it's a great headline but the reality is Buffett got himself a shrewd deal regardless of what happens with the equity from here.
As I said in my post, if he is now going to actively work toward creating workable marks for the toxassets, that's another thing entirely. But that remains to be seen.
Posted by: Jason Wood | September 24, 2008 at 06:31 AM
Jason,
Glad to see you back!
Very interesting deal. Makes for great headlines and maybe a quick rally but looking at the terms makes me question how bad GS needed the capital. Quick back of the envelope math, 5 year warrant, 47% vol (historic), strike 115, exercisable at any time with common at $125 would be worth in excess of $50.00. This number is conservative as the 10% div on the preferred isn't even factored in. Culturally Warren is a perfect fit should he exercise but the terms of the deal are quite interesting at first take. I'll be interested in how the street views the deal.
Posted by: John P | September 24, 2008 at 01:02 AM