Buffett Swarms In

It must be humbling to be Warren Buffett.

Consider: In the past few days, financial markets have been granted:

  • A ban on short-selling.
  • Permission for the last two independent investment banks to register as bank holding companies.
  • The mother of all bailouts.

Sure, those actions helped to get emotions under control, but a heavy sense of fear still lingered.

In walks Buffett
But what really got things moving -- and, amazingly, what seems to have provided some people with the feeling that we've (dare I say it?) reached a bottom -- was the announcement that Buffett's Berkshire Hathaway (NYSE: BRK-B  ) is buying a huge stake in Goldman Sachs (NYSE: GS  ) .

Berkshire will purchase $5 billion worth of Goldman "perpetual" preferred stock with a yield of 10%. The purchase comes with warrants to buy $5 billion worth of common stock at $115 per share, or about 8% below where Goldman closed on Tuesday. If the warrants -- which are good for the next five years -- are exercised, Berkshire could effectively own around 7% of the company. Its stake in Goldman would potentially be bigger than its positions in Wells Fargo (NYSE: WFC  ) and US Bancorp (NYSE: USB  ) , and it would become Berkshire's largest stock position behind Coca-Cola (NYSE: KO  ) . This is a big deal, folks.

Why this is important
Buffett has stayed away from the investment-banking scene ever since he had to temporarily step in as interim chairman at Salomon Brothers -- now part of Citigroup (NYSE: C  ) -- in the early '90s amid a bond-trading scandal that nearly sent the company into bankruptcy.

What turned him off? Well, investment banks are about as bamboozling as things get -- and in fact, they're a big part of the reason we're in this mess. As recently as May, CNBC reported: "[Buffett] recently considered the prospects of a large investment bank ... by reading its 270-page annual report. He said he highlighted 25 pages where he did not understand what he had read." Admit it: If he can't understand it, no one can.

So why the sudden change of heart? Please don't confuse me with someone who thinks he knows what Buffett's thinking, but my guess is that this weekend's developments -- which began the process of turning Goldman and Morgan Stanley (NYSE: MS  ) into bank holding companies -- changes the game enough to where Buffett's willing to get his toes wet with these beleaguered names.

With the new structure, Goldman will be required to pare back its leverage ratio, a move that effectively de-risks and de-complicates the company. What's left will be a stripped-down company that, with less risk, can still exploit the asset that's brought Goldman so much success over the years: its top-tier work force, best-of-breed management, and unrivaled global reputation as the premier investment bank. Sealing the deal, the market hullabaloo we've seen lately pushed Goldman down to what Buffett probably saw as a pretty attractive price.

Buffett's being brave. Maybe you should be, too.
But here's what's really important about this deal: Buffett's buy sends a strong message to markets around the world: "Hey, it might not be as bad as you think. I'm not panicking. I don't think the world is coming to an end. I'm finding bargains, and you should be, too."

More so than Ben Bernanke and Hank Paulson combined, Buffett's seal of approval has the ability to soothe markets that are completely besieged by fright. There's such a lack of information over what's going on that panic has seemed to be the suitable response. Get Buffett to step up like Papa Bear and provide a sliver of guidance on where we're heading, and things are bound to cool off -- thank goodness.

What to do now
So should you jump back into financial stocks? For the majority of banks, the answer is still a big fat no. Keep in mind that Goldman is in a league of its own, and the terms Buffett got on this deal are far, far better than what you and I could receive. For one, he got specially issued preferred shares. For another, they came with warrants that give him tremendous upside potential without essentially taking on any more risk. 

Even so, this is Buffett's first big financial deal since the credit crunch started more than a year ago. If there's a better sign that things might be starting to reach a bottom, I'm not sure what it is.

For related Foolishness:

Fool contributor Morgan Housel owns shares in Berkshire Hathaway but none of the other companies mentioned in this article. US Bancorp is a Motley Fool Income Investor pick. Coca-Cola and Berkshire are Motley Fool Inside Value selections. Berkshire is also a Stock Advisor pick. The Fool owns shares of Berkshire Hathaway and has a disclosure policy.


Read/Post Comments (13) | Recommend This Article (47)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 24, 2008, at 11:30 AM, Terrak wrote:

    Like the man says, be greedy when others are fearful.

    Can we just legally change W.B.'s name to "The Man", or possibly "The Myth" or "The Legend"?

  • Report this Comment On September 24, 2008, at 12:07 PM, scorp99cam wrote:

    "The Myth" would suggest it's not true though

  • Report this Comment On September 24, 2008, at 12:18 PM, UncleSkell wrote:

    Does this bring to mind that time on October 25, 1929, when Richard Whitney (vice president of the New York Stock Exchange and later,convicted embezzler) walked onto the trading floor of the exchange and announced that he wanted to buy a large quantity of US Steel stock?

    Probably not the same thing at all, but my point is, something that looks a lot like Warren Buffett buying a bunch of stock in a troubled company during a crisis happened in 1929, and it did not turn out well. Probably not the same thing at all, but it's sure giving me the heebie-jeebies.

    (Sorry to post twice, but the closing parenthesis and a couple of words got dropped.)

  • Report this Comment On September 24, 2008, at 12:40 PM, SteveTheInvestor wrote:

    I'm not sure what motivated Buffett to make his purchase but I don't think it will change my view that the market is still not worth investing in at this point (especially financials). Way too many problems still to be worked through for my tastes.

    Buffett is buying for a corporation that he expects will still be around 100 or 200 years from now. Pretty much irrelevant for real people investing for themselves.

    It could be several years before this garbage is worked through. If the bank stocks and mortgage defaults don't get me, the bailout package will due to higher taxes, inflation and a lousy economy.

  • Report this Comment On September 24, 2008, at 4:23 PM, Buckeye46 wrote:

    Buffet struck it rich one time and with his wad of cash continues to prosper. However, as a political analyst, he has tanked with his presidential support. In my book that's batting .500. Keep your Foolish money close to your vest.

  • Report this Comment On September 24, 2008, at 5:33 PM, X99 wrote:

    WB is not just one of "the guys" who thinks he knows what's up. He DOES know what's up. He has a proven public track record, rather than the bull that comes from the mouths of the the public. I am sick of people and news articles giving their advice without any public track record.

    Yes, this is cetainly a signal the bottom is near. Yes, I added to my BRK position today and yes, I fully expect it to gain 30% over the next year and 60% over the next 2 years. No question, follow his lead.

    Most of the comments so far simply prove WB theory of buying when others are fearful.

  • Report this Comment On September 24, 2008, at 8:42 PM, jack21222 wrote:

    Not only does he know what's up... he IS up. He invented up, in my opinion.

  • Report this Comment On September 25, 2008, at 12:46 AM, MadDogCase26 wrote:

    This isn't the deal many people assume it is. I would definitely do his deal but it is worlds apart from Buffett simply buying the stock of it's own right. The warrants allow him to increase his possible upside greatly. He's getting 10%!!! already, plus whatever premium he gets from the warrants. Berkshires going to be a better buy than Goldman with that deal!

  • Report this Comment On September 25, 2008, at 9:59 AM, Pmccorm wrote:

    If it is good for Buffet, why is it not good for the US taxpayer??!! Why is the Congress not demanding preferred shares in return for our 700 billion??!!!!

    The Swedes could do it:

    http://www.nytimes.com/2008/09/23/business/worldbusiness/23k...

  • Report this Comment On September 29, 2008, at 1:49 AM, pvanb wrote:

    EVERY market needs rules and some regulation, or chaos ensues, as the US financial market has seen so far. The 1930's was in part caused by free wheeling banks, until the government (see Roosevelt) reined them in with laws to limit their more dicey practices. Those who refuse to learn from history are doomed to repeat it. The US Congress, with the acquesence of the Executive (see Clinton) saw fit to repeal those rules and lessen the common sense restrictions on the banks, and at the same time impose some social engineering constraints on the financial institutions, (see equal opportunity financing for societal groups and geographic areas). For instance same amount of dollars lent to "disadvantged areas" as well as more affluent areas. Economic suicide for banks in the long term. So the "bailout" is justified as government initially engineered it, and people (taxpayers) elected the government. You get the kind of government you elect. Try trading "free enterprise, liberty and the pursuit of happiness" for "peace, order and GOOD government". The might mean adding a third political party to you tweedledee and tweedledum partys (republicans and democrats) and elect a real meaningful party that can LEAD, and not just argue.

  • Report this Comment On September 29, 2008, at 9:58 AM, scottindallas wrote:

    Ummm, you really didn't read or analyze what Buffet did. Where in this market can one get as safe a 10% return? Further, the return is likely higher as GS is down, but Buffet is getting an 8% discount.

    So, will others get this 18% consideration? Of course not. This is a marketing ploy, a lost leader paid to Buffet to fool suckers like you into touting GS.

    GS has manipulated oil futures to drive them up. They should be investigated for their $200/barrel claims. I dare say these oil futures contracts coming due last week is what brought this crisis to a head.

    I don't know if you were on top of the oil speculation hype that we've seen for the past 3 yrs, where we've had surpluses for nearly all but the 2 weeks after Katrina/Rita and Gustav/Ike.

    You have been bamboozled by hype over facts on this GS/Buffet marketing ploy. Were you also fooled by GS's bold claims of $200/barrel oil? But oil trader's claims that oil was short when we were weekly running 1million barrel/week surpluses according to the Energy Dept and the Petroleum Institute?

  • Report this Comment On September 29, 2008, at 3:31 PM, lluluien wrote:

    Here is the roll call vote from the House for resolution 3997 - the "Bailout". Now you can find out whether or not you need to call your Representative to tell him he's being voted out if he votes in favor of this again when it comes up for the next try. I already called Ike Skelton to tell him I'm voting for his opponent in the next election:

    http://clerk.house.gov/evs/2008/roll674.xml

  • Report this Comment On September 30, 2008, at 12:11 AM, ejlog12 wrote:

    lluluien, thanks for that link..I will be contacting my rep to support his vote IN FAVOR of the rescue plan.

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