Take this $25 billion or else!

This is basically what Hank Paulson said to the CEO of Wells Fargo and other top bank CEOs after they said, “No thanks” to the Govt subsidy. Taking the money meant that the U.S. Govt would have some say in how the ran their businesses and they wanted no part of it. Granted most men in the room needed the cash and were in serious need of this low cost liquidity, but to those that did not need it, these “investments” would come at a high cost to other shareholders. To combat this insurrection, Paulson gave them a deal “that they could not refuse.” He told them that if their bank did not take this cash and it ran into trouble later, that he would let it take the “Lehman route,” and help from the Treasury would not be forthcoming.

Warren Buffett is not too happy about seeing his $5B investment in Goldman Sachs get diluted within weeks of its announcement. Mitsubishi/UFJ also took another hit (after watching MS stock price drop 60%) to its $9B investment in Morgan Stanley. The Treasury has “Senior Preferred Shares” which means that they get paid first. If there is only enough profit to pay the 5% fee to the Govt, then Buffett will not get his 10% dividend. Although Buffett and Mitsu/UFJ can afford to take the hit for a few years, I get the feeling that Buffett feels that Hank Paulson stabbed him in the back.

When GS banker Byron Trott called Warren Buffett about an investment in the firm, Hank Paulson said that they Treasury would not invest directly into banks – period. Buffett even talked with Paulson a few times about his plans and the need for direct investment from the private sector to avoid catastrophe. This was before the BailOut bill passed, so Paulson thought that the passage of the $700B bill would be enough to prop up markets until more stabilizing measures could be taken. The problem was that the BailOut effect only lasted for 1 session on Wall Street. What followed were continuous days of losses pushing the DOW below the 8000 mark for the first time in years. Unfortunately, that was not Warren Buffett’s problem. That was Hank Paulson’s problem. So Paulson did not need Buffett’s approval to complete then announce the $125B deal on Monday.

Get me once, shame on you; Get me twice shame on me. If you were paying attention, Goldman was not the only Berkshire Hathaway investment that got diluted on Monday. Wells Fargo reluctantly accepted $25B from the Treasury because it was already planning to raise $20B on its own relating to its purchase of Wachovia. The unspoken problem was that in this market he was never going to raise the $20B in time (if ever) to keep the bank on a sure footing, so Warren advised (and Paulson demanded) Richard Kovacevich (Chairman) and John Stumpf (CEO) to accept the cash. However, Paulson did leave a “trap door” for humongous bank shareholders to retrieve their “Priority 1” status.

According to the term sheet, the Treasury can freely pass the ownership of these Senior Preferred Shares to a third-party. This means that if someone (i.e. Warren Buffett) has enough cash to buy out the U.S. Govt’s share, they will get the same terms as the Govt. Although pushing $25B to the Treasury to maintain its status in Wells Fargo is a little far fetched, Goldman Sachs only received $10B. This amount is well within Buffett’s means and would be very wise indeed.

Lets say that Berkshire Hathaway buys $5B of the Treasury’s “Golden Shares” which carry a 5% dividend for the first five years. This means that Goldman will only have to pay the Treasury $250mm and then the next $250mm goes to Buffett; then the next $500mm (from his previous investment) will also go to Buffett. Buffett already held $5B in warrants to buy common stock from GS at a later date so technically, the money was already allocated to GS. He could also buy the entire $10B from the Govt and receive $1B a year from GS, accelerating to $1.4B if not paid off in five years. Other humungous investors should look at doing a similar deal if they think the bank is secure enough to survive this thrashing.


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