Warren Buffett has received a great deal of attention and some criticism for his call on the rich to pay higher taxes. However, regardless of how one feels about his desire to contribute more to the US Treasury's coffers, it is somewhat curious that at the same time Buffett is calling for sacrifice for the common good, he is also taking advantage of our current financial troubles to reap huge returns. Buffett has developed a niche by injecting large sums of capital into major companies that are struggling, not because of poor balance sheets but because of issues with market confidence. On Thursday, Buffett invested $5 billion in preferred shares of Bank of America on very favorable terms that are similar to his transactions with Goldman Sachs and General Electric at the height of the financial crisis nearly three years ago. By investing in these companies, he gives these companies his endorsement. But like Michael Jordan, Tom Brady or any other celebrity, Buffett's endorsement comes at a very high cost.
Buffett ended up making $1.7 billion from his investment in Goldman—a return of nearly 40 percent—and his deal with Bank of America should be just as profitable. According to one analyst, Buffett will be making an annual return of over 10% on his investment. Buffett will earn this return by getting $300 million a year in dividends on his investment—which incidentally comes with a major tax break, as well as warrants which would allow him to buy 700 million shares of Bank of America at a stock price of $7.14 a share (a half dollar less than Bank of America’s valuation at the closing bell on Friday) at any time over the next decade.
While Bank of America would likely have never pursued this deal with any other investor because the relatively high cost for the amount of capital raised, there seems to be a premium for what Felix Salmon of Reuters calls the “magical Buffett fairy dust.” The fact that Buffett is backing the stock makes it somehow more valuable than it would be than if the deal had been with John Doe or possibly even with Ben Bernanke. In this Wall Street Journal round up of various analysts, almost all were impressed with Buffett’s “vote of confidence.”
Although this may remind some of the Panic of 1907 when JP Morgan single-handedly saved the stock market, this is not the case. Morgan essentially served as the equivalent of a central bank at a time before the creation of the Federal Reserve when the 1907 financial crisis occurred. He acted as the market’s backstop. Here, Buffett is jumping in because there’s the opportunity to make a buck. This is not selfless sacrifice or even an attempt to shore up the market, instead, he is merely acting as a shrewd investor. He’s not pouring cash into lame duck industries, instead he is following his value investing model—the only difference being that because the companies that he is investing in are undervalued because of a confidence crisis, his investment has positive effects on the market as a whole, not just his bottom line. It seems that Buffett has assumed this peculiar role not so much because the government trusts Buffett to serve as a proxy but because the market may trust Buffett more than it trusts the government.