Wednesday, March 27, 2013

Warren Buffet Should Thank Us: His Deal Versus Ours at Goldman Sachs

Warren Buffet Should Thank Us: His Deal Versus Ours at Goldman Sachs

In October 2008 when the financial system was on the verge of collapse, the US Government and Berkshire Hathaway stepped forward to invest in Goldman Sachs.  Back in those dark days, it was already apparent that Warren Buffet had a much better deal than the tax payers because the US Treasury had given Goldman incredibly generous terms under the TARP program.  On Tuesday, we were reminded of Berkshire Hathaway’s sweet deal, as Goldman agreed to convert 43.5 million warrants into common stock.  Even if you’re not financially savvy, you’ll see just how poorly taxpayers were compensated for the risk they took in injecting capital into Goldman.  Meanwhile Mr. Buffet’s company made much more money on a smaller investment and will wind up with a 2% position in Goldman Sachs thanks to you.
Old Car Plants (2005)

Both the US Treasury and Berkshire Hathaway invested in preferred stock.  The US Treasury invested $10 billion with a 5% dividend.  Berkshire invested $5 billion with a 10% dividend.  Warren Buffet had the comfort of knowing that the US Government was prepared to support Goldman and the entire financial system with cheap capital.

Mr. Buffet’s deal gets even better.  The US Treasury’s preferred could be redeemed by Goldman without paying any premium.  Berkshire Hathaway’s preferred required Goldman to pay a premium if it was redeemed within five years.  When Goldman paid us back in June 2009, they wired the Treasury $10 billion.  When they repaid Mr. Buffet’s company in April 2011, they returned $5 billion, plus a $500 million premium.

Both transactions included warrants to buy Goldman’s stock, but Berkshire’s deal was sweeter.  The US Treasury received 12.2 million warrants to buy stock at $122.90 per share, or 6.1 million warrants, if Goldman issued enough common stock within a specified period of time. Berkshire Hathaway received 43.5 million warrants to purchase Goldman stock at $115 per share. At the time of these deals, Goldman’s stock was trading at about $90 per share. 

The US Treasury had 10-years to find out if its Goldman warrants would be worth exercising and Berkshire only had five year.  This advantage clearly belonged to the US Treasury.  However, Berkshire many more warrants (4 to 8 times as many) at a more attractive price.

What happened?  Almost from the outset, Goldman wanted to rid itself of the Treasury’s preferred.  Goldman, like other banks, didn’t like the compensation restrictions or the “stigma” of government ownership.  After less than eight months, Goldman had paid off the government’s $10 billion preferred, and a month later paid another $1.1 billion to buy back the warrants.  Treasury trumpeted its 23% return, but sophisticated investors knew that government’s cash multiple was a paltry 1.14 times (total proceeds of $11.4 billion on a $10 billion investment).  We were poorly compensated for the risk Treasury Secretary Henry Paulson took on our behalf.
Meanwhile, Berkshire was allowed to keep receiving their 10% preferred for two and one-half years, and then as I mentioned received an extra $500 million when it was redeemed.  If Berkshire were to have converted their warrants into stock, and sold them at today’s price of $146 per share, they would have received a total return on their investment of 20% or a 1.63 times multiple ($8.1 billion in proceeds and dividends on their $5 billion investment).  Had the United States received the same treatment as Warren Buffet, our $10 billion investment would have netted us $16.3 billion, instead of the $11.4 billion we actually received. 

Treasurer Paulson, former Chairman of Goldman Sachs, gave his former firm an enormous financial windfall.  This wasn’t a case of na├»ve public bureaucrats cutting a bad deal with the private sector.  Wall Street executives, including Goldman Sachs alumni in key positions, surrounded Mr. Paulson, and structured TARP to be hugely advantageous to the banks.  As for Mr. Buffet, he owes the US taxpayers a large debt of gratitude for making his large stake in Goldman Sachs possible.

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