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Will Bank of America's Buffett Deal Backfire?

Warren Buffett
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Warren Buffett

Pulitzer Prize winning journalist Jesse Eisinger raises an important point about Bank of America—and the banking system in general.

The bank has been publicly proclaiming that it did not need more capital. But the Buffett deal, which was very expensive for Bank of America , seems to run directly counter to this.

From Eisinger:

Mr. Buffett's investment reveals something both infuriating and scary.

Bank of America has not been talking straight about its need for capital.

"You cannot have the largest bank in the country saying, 'We don't need the money,' and then paying this kind of price to Warren Buffett for capital they say they don't need," said Daniel Alpert, who runs the investment firm Westwood Capital. "Industrywide, it's a potential boomerang because we think, 'Why should we believe any of these guys when they say they don't need the money?' "

"We've been through a massive crisis in 2007 and '08 where executives of major financial institutions tried to hide their insolvency," he added. "They said, 'No, no, a thousand times no, we're fine.' And then they were gone."

Sure, Mr. Buffett reportedly approached Brian T. Moynihan, Bank of America's chief executive, who initially rebuffed the investment offer—suggesting that Bank of America didn't really need capital. Even so, Mr. Moynihan's reticence didn't last long. And if the bank truly didn't need capital, why make such an expensive deal that could dilute other shareholders?

Eisinger thinks this could have systemic implications. If people begin to think that Bank of America's financial condition was worse than it was letting on, they'll likely begin to question the health of other banks, as well. Remember that bank solvency is largely a matter of confidence: If the market loses confidence in a bank's financial condition, the bank will quickly find itself unable to continue doing business.

"The Buffett investment just might turn out to erode, not increase, confidence. And not only for Bank of America, but for the banking sector as a whole," Eisinger writes.

For it's part, Bank of America denies that the Buffett investment was driven by capital at all. It says, rather, that it has plenty of capital and can continue to grow capital organically.

"There's only one Warren Buffett. We are very happy to have him, but it wasn't driven by capital," a spokesman for the bank tells Eisinger.

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