Buffett shifts from fear to greed
The return of Warren Buffett to Wall Street, two decades after one of the biggest misjudgments of his legendary career, may ultimately be seen as a significant milestone in the progress of the credit crisis.
It is impossible to over-state the influence Buffett has with investors, large and small. He is perhaps the one private individual in the world whose actions can move markets.
While Congress wrangles over Hank Paulson’s plan to use $US700 billion of taxpayer funds to acquire distressed assets from financial institutions to free up the US system, Buffett has acted.
He had sat largely on the sidelines during the peak of the credit bubble and was unmoved by the pleas of a queue of distressed financial institutions making the pilgrimage to Omaha seeking help and capital after the bubble worst. Until now.
Last night he agreed to invest $US5 billion in perpetual preferred shares of Goldman Sachs and gained warrants that would enable his Berkshire Hathaway to buy another $US5 billion of common stock at a significant discount to its current price at any time over the next five years. Goldman also plans to raise a further $US2.5 billion through a public offering.
Buffett’s decision is a vote of confidence in Goldman, which earlier this week successfully applied – along with the other independent Wall Street investment bank still standing, Morgan Stanley – for a licence to become a bank holding company. It could also be interpreted as a sign that Buffett believes that the balance within the US financial system is shifting from risk to opportunity.
Buffett once famously said that investors should be ‘’fearful when others are greedy, and greedy when others are fearful.’’
The mood around Wall Street and, more generally, the global financial system is as fearful as it has been in several generations. For Buffett, the balance between fear and greed now favours greed.
He wouldn’t return to Wall Street lightly because his last sortie into investment banking is one of the few major blemishes on a remarkable history as an investor.
In 1987 he invested $US700 million in Salomon Inc just before it became embroiled in a bond trading scandal that almost forced it into bankruptcy. He was forced to take on the chief executive’s role to convince the authorities not to withdraw the firm’s licence to deal in Treasury bills and spent two years salvaging the firm and its reputation before selling it to Citigroup.
Buffett may see value in Goldman but has been cautious. Not only has he chosen to back the best of the Wall Street firms – Goldman has been less damaged by the crisis than any of its peers – but he has negotiated a hard bargain. The yield on the preferred stock is 10 per cent and his warrants over common stock are exercisable at an eight per cent discount to the price at which Goldman shares traded ahead of the deal.
His capital and reputation will help Goldman raise the additional $US2.5 billion. Once it becomes a bank the potential for further erosion of its capital base will be reduced because banks don’t necessarily have to mark assets to market. Indeed, Goldman will be in a good position to exploit the distress in the US system.
The Buffett deal follows hard on the heels of a conditional agreement by Japan’s Mitsubishi UFJ’s to buy as much as 20 per cent of Morgan Stanley for up to $US8.4 billion. If executed, that deal would probably secure Morgan Stanley’s future.
Stabilising what’s left of Wall Street is a small but necessary step towards reducing the amount of fear and loathing in the US system. The moves by Buffett and, to a lesser degree Mitsubishi may, regardless of the fate of the Paulson package, encourage more private sector capital to become less fearful and more greedy.
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