Fundmastery Blog

Kurt Brouwer July 23rd, 2009

This Bloomberg piece (emphasis added) gives the details on two payoffs by Goldman Sachs.  As part of the bailout loans last Fall, Goldman issued warrants (essentially options) tied to the company’s equity to the Feds.  Previously, it had accepted a preferred stock investment from  Warren Buffett’s company, Berkshire Hathaway.  The Berkshire deal also had warrants attached. Now that Goldman is doing well, it wanted to close those warrants out and, in doing so, gave both the Feds and Berkshire a nice payday.

Of course, it should be noted that Berkshire did a bit better than the Feds, but Warren Buffett is almost certainly a better negotiator than anyone the Feds could have sent in.

Berkshire Profit on Goldman Sachs Passes $2 Billion (Bloomberg, July 23, 2009, Erik Holm)

Warren Buffett’s option to buy shares of Goldman Sachs Group Inc., part of an agreement reached at the depths of the credit crisis, has earned a profit on paper of about $2 billion, a return of more than 40 percent.

Goldman Sachs today passed $162 in New York trading for the first time since rival Lehman Brothers Holdings Inc. collapsed in September. Buffett’s Omaha, Nebraska-based Berkshire Hathaway Inc. has warrants to buy $5 billion of Goldman common stock for $115 a share any time in the next four years.

“It must feel good to be Warren Buffett,” said Gerald Martin, a finance professor at American University’s Kogod School of Business in Washington, who has studied the billionaire’s investing history. “That number just flies in the face of people who like to say he’s lost a step.”

The difference between the strike price and the share value translates into a $2.11 billion paper profit for Berkshire. The U.S. government got a 23 percent annualized return for its investment in the firm after an agreement yesterday by the bank to repay $1.1 billion to settle warrants.

So the government got its $10 billion loan back plus a little sweetener on the warrants.  Buffett, not being the government, got a much better deal, but I’m not complaining. I’m glad to see the Feds made money on this deal and I hope there are more such repayments to come.

Goldman Sachs later took $10 billion from the U.S. as part of the government’s bailout of financial firms — a deal that also required the bank to grant the Treasury warrants. The U.S. Troubled Asset Relief Program charged 5 percent annually, and placed restrictions on compensation for some employees. Goldman repaid the $10 billion in June, and this week agreed to the Treasury’s request for $1.1 billion to settle the warrants…

Here is a post we did earlier this year making the point that Buffett did a much better job of deal structuring than the Feds did under then-Treasury Secretary Henry Paulson.

Buffett Got Better Deal The U.S. Treasury (Fundmasteryblog, January 9, 2009, Kurt Brouwer)

I have been saying for some time that the way to bail out the banks was not to have the U.S. Treasury invest directly. Instead, a better plan would have been for the Treasury to create a structured investment with Warren Buffett or Bill Gross or both in charge of structuring the deal.

In this approach, the government would give private investors a significant tax break on any capital invested in approved banks. Then, the government would step aside and let private investors put in capital as they see fit. In this scenario, investors would have gotten a good deal, banks would have gotten the capital they need and the U.S. Treasury would not have been on the hook for anything.

To see why this would have been better, here, is a comparison of how Buffett’s Goldman Sachs deal compares to the Treasury’s Goldman Sachs deal. This chart from Barry Ritholtz’s excellent blog illustrates the points made in a fascinating Bloomberg piece (see below):

Source: Barry Ritholtz

This piece from Bloomberg was included in the original post because it gives the details on how poorly the U.S. Treasury fared in its bank investments versus Warren Buffett’s investment in Goldman Sachs [emphasis added]:

Paulson Bank Bailout in ‘Great Stress’ Misses Terms Buffett Won (Bloomberg, January 10, 2009, Mark Pittman)

Henry Paulson’s bank bailouts, done under “great stress” during the worst financial crisis since the Great Depression, failed to win for U.S. taxpayers what Warren Buffett received for his shareholders by investing in Goldman Sachs Group Inc.

The Treasury secretary made 174 purchases of banks’ preferred shares that include warrants to buy stock at a later date. While he invested $10 billion in Goldman Sachs in October, twice as much as Buffett did the month before, Paulson gained certificates worth one-fourth as much as the billionaire, according to data compiled by Bloomberg. The Goldman Sachs terms were repeated in most of the other bank bailouts.

Paulson’s decisions to prop up the financial system included purchasing shares in institutions from Goldman Sachs, the most profitable Wall Street firm last year, to Saigon National Bank, a Westminster, California, lender whose market value is $3.8 million.

…Paulson’s warrant deals may give taxpayers less profit from any recovery in financial stocks than shareholders such as Goldman Sachs Chief Executive Officer Lloyd Blankfein and Saudi Arabian Prince Alwaleed bin Talal, owner of 4 percent of Citigroup Inc., said Simon Johnson, former chief economist for the International Monetary Fund.

The transactions are “just egregious,” said Johnson, a fellow at the Peterson Institute for International Economics in Washington. “You want to do it the way Warren does it.”

…The Treasury would have held warrants for 116 million shares of Goldman Sachs under Buffett’s terms, which would be equivalent to a 21 percent stake when added to those currently outstanding. Instead, the dilution is 2.7 percent under the Treasury plan. Blankfein is the company’s biggest individual investor, with 2.08 million shares worth about $178 million today, according to Bloomberg data. His 0.47 percent interest would have declined to 0.36 percent under Buffett’s terms and would be 0.44 percent if the Treasury’s warrants were exercised.

…In advancing the $5 billion, Paulson accepted warrants that reward taxpayers with an additional $250 million, or 5 percent of the stake. That compares with 15 percent on the 174 completed bank rescues as well as the 100 percent Berkshire Hathaway Inc. Chairman Buffett obtained on an investment in Goldman Sachs in September, Bloomberg data show. A warrant is a company-issued certificate that represents an option to buy a certain number of shares at a specific price by a predetermined date.

…If the Treasury had received the same terms as Buffett, taxpayers would have become the biggest investors in most of the bailed-out banks and existing stakes would have been diluted, Bloomberg data show…

Based on the outcome of the two deals, I think it is fair to say that the government got a much worse deal than a savvy private investor obtained.  As I pointed out above, I think we would have been better off just giving investors a tax break for investing in banks. Let Warren Buffett or Bill Gross negotiate a deal and then have the banks offer it to all comers, plus a nice tax break from the Feds. If we had done so, I believe the capital would have poured in and, the Treasury would have had none of our taxpayer money at risk.

Full Disclosure: Kurt Brouwer owns Berkshire Hathaway (brk-b)

• Business , Geopolitics , Investing , debt
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