Maybe the American taxpayers should be asking Warren Buffett to be negotiating on their behalf.
Treasury Secretary Henry Paulson has spent a good part of the last two days on Capitol Hill arguing that the government should not demand a stake in any Wall Street firms it bails out. Demanding such a stake, Mr. Paulson says, could scare away many of those firms from participating in the bailout, leaving the credit markets as hobbled as they are now.
And then Mr. Buffett swooped in on Tuesday evening and announced that his company, Berkshire Hathaway , was investing $5 billion in Goldman Sachs , money that would help the firm — which made far fewer bad investments than most of Wall Street — shore up its balance sheet. What will he receive in exchange for his investment? Something like a 7 percent stake in the firm.
Mr. Paulson, of course, has a different objective than Mr. Buffett. The Treasury secretary is trying to resuscitate the country’s financial system and keep the economy from falling into a deep recession. If he drives too hard a bargain, he won’t solve the problem. Mr. Buffet is merely trying to make some money.
But to the many critics of the Paulson plan, the juxtaposition of the Goldman deal and the proposed bailout crystallize the problems with the plan. The critics are worried that the government is taking on too much risk with too little upside. And they can’t help but notice that other governments that faced similar crises in recent decades — in Japan and Sweden — struck deals that looked more like Mr. Buffett’s than Mr. Paulson’s.
On Wednesday, several members of Congress wistfully mentioned the Goldman deal. “When Warren Buffett invests $5 billion, he gets preferred stock in Goldman Sachs,” Jeff Bingaman, a Democratic senator from New Mexico, said to Ben Bernanke, the Federal Reserve chairman. “We’re being asked to endorse a bailout where we basically take the assets that these companies — these firms — can’t otherwise dispose of at a reasonable price.”
Mr. Buffett appears to have gotten a very good deal, one that may not have been available to anybody whose name carries less prestige — which is to say, just about anybody else. (He will receive dividends that will effectively pay him a 10 percent annual return on his investment, as well as the right to buy a sizable stake in Goldman at a price below the current market price.) Goldman partners figured that his investment would allow them to turn around and raise yet more capital from other investors. Sure enough, they announced Wednesday that they were doing so.
A firm that accepted money from the Treasury Department would get none of this halo effect. If anything, investors might view a firm desperate enough to approach the Treasury as an endangered species unworthy of further investment.
But as imperfect as the Buffett analogy may be, it still raises a real question: Is the government getting a raw deal? The inability of Mr. Paulson and Mr. Bernanke — as well as President Bush — to make people comfortable with the answer is the main reason that the bailout has encountered so much hostility.
Economists overwhelmingly agree that the risk facing the economy is serious enough to need quick, bold action. Yet they’re deeply skeptical that Mr. Paulson’s plan is the right one. Mr. Buffett’s deal nicely highlights their two main worries.
The first is that the Paulson plan may not have the best chance of success. Mr. Buffett’s deal with Goldman injects $5 billion in cash into the firm, and those dollars strengthen Goldman’s balance sheet. Goldman will then presumably become more willing to lend money, and the credit crisis will be one small step closer to lifting.
The Japanese government, after years of missteps, followed a strategy much like this one in 1998, putting capital directly into its banks. The move helped end that country’s long downturn.
Mr. Paulson, on the other hand, has asked for a $700 billion credit line to buy distressed assets from financial firms. It’s the equivalent of trying to cut a tumor out of the financial system. But there is a potential downside.
The Treasury wouldn’t just be giving money to the firms. It would be buying an asset of some value (albeit much less value than a year ago). As a result, the transaction might not do enough to bolster the firms’ balance sheets.
The second worry is that even if the Paulson plan works, it may end up being needlessly expensive. There is huge uncertainty about the true value of those distressed assets. If the government overpays for them, it won’t have any way to recoup the money.
Without an ownership stake — like the one Mr. Buffett got or the one the Swedish government got when it bailed out its banks in the 1990s — taxpayers wouldn’t really be able to share in the bounty of a Wall Street recovery.
Now, what would Mr. Buffett have said if Goldman asked for his money and wouldn’t let him share in the upside? “He would have said ‘no deal!’ ” said Daniel Alpert, of Westwood Capital, an investment firm. “And that is what Congress must say as well in defense of the American people.”
On Capitol Hill, Mr. Bernanke and Mr. Paulson answered their critics by returning to the same point they have made before. If companies must hand over an ownership stake, only the sickest may come forward. Others may wait out the crisis, confident they can survive. But the credit markets would meanwhile remain paralyzed, as a Treasury official argued to me, and the economy could deteriorate.
It’s certainly possible that the Fed and Treasury are right. But the Goldman deal — in which a firm that didn’t seem near extinction voluntarily agreed to give up a fat equity stake in exchange for cash — puts the onus on Mr. Bernanke and Mr. Paulson to make a better case than they have so far.
Mr. Bernanke pointed out Wednesday that Mr. Buffett had urged Congress to pass the current bailout plan. I’d point out that Mr. Buffett drove a harder bargain when his own money was on the line.