Why must the American tax payer be responsible for buying assets that some of the smartest business and investment minds in the world aren't willing to buy? I understand that many Americans are struggling to pay bills, losing jobs, and watching their retirements disappear; however, establishing a new Government Entity to buy up to $700 billion in distressed assets from US financial institutions in an attempt to relieve stress in capital markets may not be the best idea.
Americans must understand why these bad assets create a tightening of credit. One measure used to determine the perceived health of a financial institution is that institutions capital ratio. Capital ratios are benchmarks established to force financial institutions to maintain a cushion of capital in reserve that would cover potential losses. Regulators mandate that a well-capitalized bank's capital (common stock, preferred stock, and retained earnings) represent more than 10 percent of its risk-weighted assets. For all intents and purposes there are two methods to improve a financial insitutions capital ratio: 1) sell distressed assets for more than you currently have that asset valued on you balance sheet; or 2) raise capital.
The Government's current bail out plan, passed in the US Senate on October 1, 2008, would provide the Government $700 billion to buy distressed assets from US financial institutions. What know one seems to be talking about is that the only way this plan aids the financial insititutions lucky enough to participate in the “bail out” is that the Government must pay these institutions above current market prices for the securities in order to relieve the stress on the institutions capital ratio. In other words, the government has to pay 15 cents for an asset some of the brightest minds in the financial world calculate is only worth 10 cents. Understanding that the current value of the securities is not necessarily a true representation of the value of the underlying cash flow of the collateral, and that the government may actually make money in the long run if they can accurately value the assets in today's market, but what if they are wrong.
Over the last two weeks, while the Government has marched on with the $700 billion asset purchase bail out plan, many of the brightes business minds in America have thrown out alternative. Two of these individuals, Warren Buffet and Steve Wynn have either invested in financial companies or believe injecting capital is far more effective, cost less and potential more financial rewarding.
Warren Buffet, the world's wealthiest person (estimate fortune of $60 billion) and has one of the most successful business track records of all time, yet his company, Berkshire Hathaway is not buying distressed assets from financial institutions.
On September 23, 2008 Berkshire Hathaway invested $5 billion (with an option for an additional $5 billion) directly into Goldman Sachs through perpetual preferred with a 10 percent dividend yield. In addition, Berkshire received warrants to buy $5 billion of Goldman Sachs shares with a strike price of $115 per share effective immediately and a 10 percent penalty if Goldman Sachs calls the stock before the five year agreement ends. For Goldman Sachs, they receive an injection of $5 billion in capital resulting in immediate relief of the perceived stress on its capital ratio. Rather than buy distressed assets from Goldman Sachs at above market rates, Berkshire will receive $500 million per year for its investment and Goldman received much needed capital.
On October 1, 2008 Berkshire Hathaway was at it again. Berkshire invested $3 billion (with an option for an additional $3 billion) into GE through preferred stock with a 10 percent dividend yield, warrants to by GE stock at $22.25 exercisable at any time for a five-year term, and is callable after three years at a 10 percent premium.
Steve Wynn, President and Chief Executive of Wynn Resorts stated September 30, 2008, that Warren Buffet has shown us the way. He believes that our GDP simply cannot afford $700 billion, with a current budget deficit of $350 billion. He believes the assets should remain with the companies that bought or underwrote them, and that the Government should let each institution know “we're going to save you, but you have to cut your operating expenses, pay bare minimum salaries, no bonuses, until the government gets its money back. What will happen is the bankers will say tomorrow okay, let people stay in those homes. Instead of the Ditech commercial where you had people saying forget about paperwork. They'll ask them to show how much they afford. Loans will get renegotiated. Homes will go back to $250,000. The people that live in them will pay what they can afford. The banks will have huge tax losses. The stocks will drop, just like they're supposed to. This phony inflation in the economy will end.” Why can't Paulson, Bernanke and Congress see this too?
So let me get this straight, the US Government has chosen to buy $700 billion worth of mortgage and mortgage like securities; however, you could actually achieve the same result by injecting only $70 billion of capital in the form of preferred stock. If teh US Governement used Warren Buffet's roadmap, they could receive a 10 percent dividend and warrants to buy the stocks of the companies they would be investing for a thre to five year term. Hey, I have a good idea, let's put an enormous amount of money ($700 billion) to work and “hope” we get our money back and “maybe” even make a little money, or lets put 1/10 the money to work, make a $7 billion per year dividend (5-years = $35 billion) for the government, with the possibility to make a whole lot of money if the companies succeed. I understand stock is generally a far more risky investment, but given the state of the US economy, economies around the world, and the fact that the US Government is going to have to borrow the money in order to make either investment, I am pretty sure I would prefer to put a much smaller amount of money to work with a much higher rate of return, then increase the current budget deficit by 200 percent and maybe get my money back. I hope they are right.
