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.
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