November 2009

There is a long list of people who are accused of unfairly profiting from our national financial crisis – Hank Paulson, John Thain, anyone who has ever worked at Goldman Sachs, AIG, Fannie Mae, and Freddie Mac. But no one ever mentions Warren Buffett. The “Oracle of Omaha,” however, has arguably benefited as much or more than anyone from the US taxpayer funded bailout of the financial industry. Consider Mr. Buffett’s investment in Goldman Sachs on September 24, 2008 via his Berkshire Hathaway holding company. Goldman stock was trading at $125 when Mr. Buffett offered his cash infusion. In exchange for $5 billion, he received $5 billion worth of preferred stock. His preferred shares included a 10% dividend and warrants, which granted him the right to purchase up to an additional $5 billion in Goldman stock at $115 per share. That price was an 8% discount at the time. One month after his initial investment, as the financial crisis worsened, Goldman Sachs was trading below $100 per share. The decline from $125 more than offset the value of Mr. Buffett’s preferred share’s dividend. Mr. Buffett, meanwhile, also had a stake in Wells Fargo that he had increased to over $9 billion in early 2008. Wells Fargo was also struggling with its own large loan losses, which were compounded by the bad decisions made by newly-acquired Wachovia. Concerned about what was happening with major financial companies, the government began to take extreme measures to support nine institutions that it had deemed “too big to fail.” The largest investor in two of them was Mr. Buffett. Wells Fargo received $25 billion of TARP funds. Goldman Sachs, meanwhile, got $10 billion in taxpayer money. Both companies also took advantage of FDIC guarantees to issue new debt, which was far below market rates and did not dilute the existing shareholders. These FDIC guarantees were arguably even more valuable to the recipient companies than the TARP cash injections because without them their futures were in doubt; any attempt to issue debt would have likely resulted in exorbitant interest rates and a reduction in the percentage of the company owned by existing shareholders. The net result of these actions was a tremendous financial windfall for Mr. Buffett. Goldman Stock rebounded from a low of $52 per share, which was more than 50% below his original purchase price, to climb above $170. Wells Fargo bottomed out below $9 per share but presently trades at over $28. These developments have further enriched Mr. Buffett. Recent published estimates put his profit at over $2 billion on just the Goldman investment. Mr. Buffett, of course, is renowned for his investing prowess and deserves credit for seeing value in these companies during a crisis. Less insightful investors and economists doubted the futures of Goldman and Wells Fargo. There is, nonetheless, what appears to be an inherent unfairness in Mr. Buffett’s returns and those paid to the American taxpayers for their bailout investments. Estimates of Mr. Buffett’s profit appear to be 40%+ in less than 12 months. Taxpayers, though, were less fortunate; they invested twice as much in Goldman, paid 20% less than Mr. Buffett for stock, but only received $1.1 billion in profits. The Goldman case, surprisingly, was not an isolated incident. Mr. Buffett had investments in multiple companies that were receiving federal TARP funds. Publicly disclosed stock holdings show more than 30% of his investments were in companies bailed out by TARP. He also enjoyed the benefit of having his large holdings in these businesses added to the federal TARP list and that relieved them from the burden of having to survive on their own merits in a bad economy, which was the fate of less privileged firms like Lehman Brothers, Washington Mutual, Wachovia and Bear Stearns. No one is suggesting Mr. Buffett or his firm Berkshire Hathaway have acted unethically. His character and judgment have been above reproach in the investment community. Regardless, there is little doubt that if the exact scenario above had played out with the primary investor being not the affable Mr. Buffett, but instead a multi-billion dollar hedge fund from Greenwich or a state-owned investment fund from China, there would have been immediate Congressional hearings and demands that “profits reaped from a US Taxpayer bailout” be subjected to special taxes or other claw backs. The unasked question is why no one has ever complained about Mr. Buffett’s multi-billion dollar bonus provided courtesy of the US taxpayers. And that’s a question worth asking.

Its signature foreclosure-prevention plan having definitively failed to actually help very many homeowners, the Obama administration today announced its new strategy to get balky lenders to the table: Nagging. The U.S. government will start to publicly identify those companies that are failing to give troubled homeowners permanent loan modifications, and hound them daily to monitor their progress, the Treasury Department declared. Top servicers will be required to submit a schedule demonstrating their plans to reach a decision on each loan for which they have documentation and to communicate either a modification agreement or denial letter to those borrowers. Treasury/Fannie Mae “account liaisons” are being assigned to these servicers and will follow up daily as necessary to monitor progress against the servicer’s plan. Daily progress will be aggregated by the end of each business day and reported to the Administration. The Home Affordable Modification Program (HAMP) was launched in March to much fanfare as the administration’s main response to a growing foreclosure problem. The government would provide cash incentives to mortgage servicers that reduced monthly payments for distressed homeowners, and that way those who were facing higher payments or lower incomes could stay in their homes. But the program, which the administration refers to as “a primary focus of financial stability efforts,” has been a disaster according to consumer advocates, economists, housing experts and government watchdogs. It does nothing for those who have lost their jobs, because they have too little income to qualify, and could make things even worse in the long run for those homeowners who owe more on their mortgage than their homes are worth, because the plan does not require principal reductions. Furthermore, only a tiny proportion of the relatively few homeowners in the program have obtained permanent relief. As of Sept. 1, only 1,711 homeowners, or less than two percent of those who received a temporary modification under Obama’s plan, ended up with a permanent fix, according to a report by the Elizabeth Warren-led Congressional Oversight Panel. And yet, the plan has cost taxpayers about $27 billion so far. Meanwhile, as many as 3.4 million homes are expected to enter foreclosure by year’s end, with some experts estimating that next year will be even worse. The administration’s latest push — shaming the mortgage companies — is “certainly a step forward after six months of operation,” says Alan White, a law professor at Valparaiso University who has written extensively on mortgages and foreclosures. “But it’s not going to help by itself.” “It’s a long-overdue step,” he said. “At this point, the servicers are propped up in [many] different ways by the taxpayer — HAMP isn’t the only subsidy they’re getting — and if we’re going to prop them up then they ought to achieve our public policy objective.” The four big banks are also the biggest servicers, he noted, and American taxpayers are the majority shareholders in three of them: Bank of America, Citigroup and Wells Fargo. “He who pays the piper should call the tune.” Others were even more critical. “The Obama administration’s latest adjustments to its nine-month-old foreclosure prevention program do little but highlight the continued failure of lenders’ voluntary efforts to stop the foreclosure crisis,” Michael Calhoun, president of the Center for Responsible Lending (CRL), a consumer-advocacy group, said in a statement. Consumers advocates have long said that the program is poorly managed and relies too heavily on mortgage servicers, whose interests are not necessarily aligned with those of homeowners. Economists and advocates point to principal reduction, for example, as perhaps the best way to achieve a permanent, sustainable modification. Lowering the total amount due — particularly for those homeowners with negative equity — could induce homeowners to keep up with their payments and stay in their homes. But most servicers and banks are loath to reduce principal, particularly for those mortgages that have been securitized. Also, servicers’ fees are based on the overall balance of the loan, so if the balance of the loan is reduced, then so are their fees.’ In the administration’s plan, the servicers essentially call the shots, rather than the investors — and yet they still don’t want to participate. One reason is that reducing the principal forces banks to recognize the losses on those loans. By not reducing the principal, the banks can essentially pretend that the loans may one day become current again. It’s an accounting trick, consumer advocates say. Yale economist John Geanakoplos is among those arguing that principal reduction is the best way to reduce foreclosures. By contrast, the administration simply requires that homeowners’ monthly payments be lowered, which can happen either through an interest rate reduction, or by lengthening the term of the loan. If a bank turns a 30-year mortgage into a 40-year mortgage, for instance, the homeowner could see the monthly payments drop — but with 10 years of extra interest, would actually end up owing more.