Goldman to Raise Capital, With $5 Billion From Buffett

http://www.nytimes.com/2008/09/24/business/24goldman.html?_r=1&hp&oref=slogin

Published: September 23, 2008

Warren E. Buffett, the country’s most famous investor and one of the world’s richest men, announced on Tuesday that he would invest $5 billion in Goldman Sachs, the embattled Wall Street titan, in a move that could bolster confidence in the financial markets.

Statement From Goldman Sachs (goldmansachs.com)

Until now, Mr. Buffett, who has navigated the stock market with legendary prowess, has largely refrained from investing in the stricken financial industry, saying repeatedly that things could get worse.

Thousands of people on and off Wall Street follow Mr. Buffett’s moves, so his decision to invest in Goldman immediately heartened investors. After falling nearly 1.5 percent during the day, the Standard & Poor’s 500-stock index erased half its loss in after-hours trading Tuesday evening on news of the investment.

“Buffett is saying he’s confident,” said Brad Hintz, an analyst at Sanford C. Bernstein & Company.

Mr. Buffett’s conglomerate, Berkshire Hathaway, unveiled the move only days after Goldman, long the premier investment house on Wall Street, embarked on a radical plan to transform itself into a traditional bank to ensure its survival. Goldman, which examined various options over the last week as its shares tumbled and some clients abandoned the firm, also said Tuesday it would sell at least $2.5 billion of common stock to the public.

Since credit markets tightened more than a year ago, Mr. Buffett had stayed his hand even as other investors, including government-controlled funds from the Middle East and Asia, poured money into American financial companies like Citigroup and Merrill Lynch, only to see their investments plunge in value.

Such wariness is a hallmark of Mr. Buffett’s investing style, and many on Wall Street have wondered when he might jump in. Over the last four decades, he has built Berkshire, which is based in Omaha, into one of the world’s largest and most successful insurers. Along the way, he has also assembled a stable of holdings in widely known companies like Coca-Cola and the Washington Post Company, and more recently has increased his stakes in energy concerns and railroads.

Mr. Buffett, who plans to donate the vast majority of his fortune to charity, is known for his folksy guidelines for proper corporate governance and his investment expertise. His annual meetings are fondly referred to as the Woodstock of American capitalism by his many acolytes.

But Mr. Buffett, 78, has also learned from past mistakes in the financial sector. For instance, Berkshire’s 1998 acquisition of General Re, the insurance company, was marred by a portfolio of complex derivative securities and state and federal investigations into reinsurance policies written by the company. Salomon Brothers, the Wall Street firm that Mr. Buffett was pressed by the government to lead in the early 1990s amid a trading scandal, was another taxing experience.

But Goldman is a classic Buffett play: It is a blue-chip institution, with a premier brand and long, successful history, that has been beaten down in the stock market, and one that he is investing in on very favorable terms. Goldman’s share price has fallen nearly 42 percent this year, and reached a peak of $247.92 less than a year ago.

Mr. Buffett, in the statement, called Goldman Sachs an exceptional institution.

“It has an unrivaled global franchise,” Mr. Buffett said, “a proven and deep management team and the intellectual and financial capital to continue its track record of outperformance.”

Still, Mr. Buffett is not taking big risks based on the structure of the investment.

Berkshire Hathaway will receive perpetual preferred shares in Goldman, which will pay a 10 annual percent dividend, or $500 million a year. Those dividends take precedence over other payments to common shareholders. Goldman has the right to buy back the shares at any time for premium of 10 percent.

In addition, Berkshire Hathaway will receive warrants to buy $5 billion in common stock at a strike price of $115 a share, which can be used at any time in a five-year period. Those warrants are already in the money: Goldman shares closed Tuesday at $125.05, up $4.27, and rose to $134.75 in after-hours trading after Mr. Buffett’s investment was announced.

While Mr. Buffett’s risks may be limited, he is investing in Goldman at a time when many fear the bank’s long-run of soaring profits may be coming to an end. As a federally regulated bank holding company, Goldman may not be able to take the kind of risks that have yielded profits and bonuses that defined Wall Street’s latest Golden Age.

Goldman’s move came a day after a rival investment bank, Morgan Stanley, raised about $8 billion by selling up to a 20 percent stake to Mitsubishi UFJ Financial Group, Japan’s largest commercial bank. Goldman was widely expected to follow suit.

“We are pleased that given our longstanding relationship, Warren Buffett, arguably the world’s most admired and successful investor, has decided to make such a significant investment in Goldman Sachs. We view it as a strong validation of our client franchise and future prospects,” the chief executive of Goldman, Lloyd C. Blankfein, said in the statement. “This investment will further bolster our strong capitalization and liquidity position.”

For Mr. Buffett, the move is a long-awaited investment in a big financial firm. Though he has struck several deals since the credit market tightened — and in two deals actually provided financing — he has not invested heavily in the financial services sector. He has been approached several times, including by the American International Group, the giant insurance company the government has since rescued.

Goldman, Morgan Stanley Buy Time for Deals by Becoming Banks

http://www.bloomberg.com/apps/news?pid=20601103&sid=aXdM4uWfeQDY&refer=news

By Christine Harper

Sept. 23 (Bloomberg) -- Goldman Sachs Group Inc. and Morgan Stanley have won a respite from investor panic by transforming themselves into bank holding companies.

The change in status allows the last two major independent investment banks on Wall Street to take advantage of different accounting rules, gives them more access to federal funds and buys them time to stabilize their funding base by acquiring deposits, analysts said.

``The move appears aimed at improving market confidence but does not, in our view, signal a major change in the business model,'' Richard Staite, an analyst at Atlantic Equities in London, wrote in a note to investors yesterday. ``The move provides Goldman with time to continue the process of de-risking itself to a level deemed suitable by the market.''

Instead of carrying all of their loans, bonds, stocks and other assets at market value, as investment banks are required to do, the two New York-based firms can now avoid further writedowns by moving some assets into their banking units. They will also gain the ability to borrow from the Federal Reserve indefinitely, an improvement over the primary-dealer credit facility that is scheduled to expire in January.

Now it's up to the banks to raise enough capital and attract enough stable, low-cost deposits to reassure investors that market gyrations won't drive them out of business. Morgan Stanley said yesterday that it plans to sellas much as 20 percent of the firm to Tokyo-based Mitsubishi UFJ Financial Group Inc. for $8.4 billion. Goldman has no immediate plans to raise capital, although it may decide to if it finds attractive investment opportunities, spokesman Lucas van Praag said yesterday.

Deposit Bases

The S&P 500 Financials Index dropped 8.5 percent yesterday as investors lost confidence that a proposed U.S. $700 billion government bailout would solve the industry's bad-debt problem. After dropping 27 percent last week, Morgan Stanley's stock was little changed yesterday. Goldman's shares, which fell 16 percent last week, dropped 7 percent.

The deposit bases of Goldman and Morgan Stanley, at $20 billion and $36 billion respectively, are much smaller than those of their largest bank competitors, according to David Hendler, an analyst at CreditSights Inc. in New York.

Morgan Stanley's deposits amounted to about 4 percent of the firm's liabilities at the end of August, while Goldman's amounted to 2 percent of liabilities, Hendler wrote in a note to investors yesterday. At larger banks, deposits typically account for between 40 percent and 60 percent of liabilities, he wrote.

``We cannot rule out that these companies could pursue bank acquisitions in order to increase their deposit funding more in- line with a typical bank,'' Hendler wrote. Yet their depressed stock prices may make Goldman and Morgan Stanley reluctant to enter deals ``until some premium has been restored.''

`Marketplace Certainty'

Both firms issued statements after the Fed approved their applications that stressed how the change would improve their image with investors. ``We understand that the market views oversight by the Federal Reserve and the ability to source insured bank deposits as providing a greater degree of safety and soundness,'' Goldman said in a statement on Sept. 21. John Mack, Morgan Stanley's chairman and chief executive officer, said the change ``offers the marketplace certainty about the strength of our financial position and our access to funding.''

Goldman Sachs, now the fourth-largest U.S. bank by market value, is more interested in buying deposits than in buying entire banks, according to a person familiar with the firm's thinking. The firm sees opportunities to buy deposits in the wholesale market and also to buy deposits of failed institutions, such as IndyMac Bancorp Inc., that are under the control of the Federal Deposit Insurance Corp., the person said.

Reducing Leverage

Morgan Stanley said it plans to ``pursue initiatives to expand the retail banking services it offers its retail clients and build a stable base of core deposits.''

In return for the advantages accorded by their new status, Goldman and Morgan Stanley won't have to change much about the way they operate. Neither firm is being required to dispose of non-financial assets, such as commodities or stakes in companies, that banks normally are prohibited from owning, for at least two years, according to the Federal Reserve orders.

Efforts by the companies to reduce their so-called leverage, or ratio of assets to shareholder equity, are more about trying to reassure markets than to meet any requirements imposed by the Fed. Instead of monitoring gross leverage, the Fed looks at firms' Tier 1 capital ratios, which measure capital requirements based on the riskiness of assets. Both firms exceed the 6 percent Tier 1 capital requirement to be deemed ``well capitalized.''

To contact the reporter on this story: Christine Harper in New York atcharper@bloomberg.net.

Paulson Debt Plan May Benefit Mostly Goldman, Morgan

http://www.bloomberg.com/apps/news?pid=20601087&sid=aUj_9.k13q7s&refer=home
By Jody Shenn
Sept. 22 (Bloomberg) -- Goldman Sachs Group Inc. and Morgan Stanley may be among the biggest beneficiaries of the $700 billion U.S. plan to buy assets from financial companies while many banks see limited aid, according to Bank of America Corp.
``Its benefits, in its current form, will be largely limited to investment banks and other banks that have aggressively written down the value of their holdings and have already recognized the attendant capital impairment,'' Jeffrey Rosenberg, Bank of America's head of credit strategy research, wrote in a report dated yesterday, without identifying particular banks.
Many banks may not participate in the Troubled Asset Relief Program because they haven't had to write down as much assets under accounting rules, meaning decisions to sell into the program would cause them to lose capital, Rosenberg wrote. Investment banks operate ``under a mark-to-market accounting model while commercial banks hold assets at cost until realizing a loss (or until they reasonably expect one),'' he wrote.
Rosenberg assumed the government will use a reverse auction in which banks submit the lowest prices they are willing to sell certain types of assets for and then the government buys the cheapest ones, with the goal of ``protecting the taxpayers,'' the report said.
Treasury Secretary Henry Paulson's push for the program, now considered by lawmakers, is designed to remove ``illiquid assets'' clogging the financial system, reverse declining asset values and prevent the freezing of lending for U.S. financial firms, companies and consumers.
The intervention into markets would be the broadest since at least the Great Depression. House Financial Services Committee Chairman Barney Frank, a Democrat from Massachusetts, said today lawmakers and Paulson narrowed differences on the plan.
Japan's Failure
In the 1990s, a Japanese government effort to buy troubled assets from banks to free up lending failed because sellers weren't willing to accept the prices offered, said L. William Seidman, a former chairman of the Federal Deposit Insurance Corp. He said that wasn't a problem he had as chairman of the Resolution Trust Corp. in the U.S., which sold off failed lenders' assets after the savings-and-loan crisis of the 1980s.
``If you're talking about institutions that haven't failed, then you have the question of whether they want to sell at a low price, particularly if that price depletes their capital,'' Seidman said in a telephone interview today.
``In Japan, we did all kinds of things, trying to have a mediator who would set a price and other kinds of methods to get around that,'' he added. ``It never really got done, so it was not successful, but here we probably have a more urgent need for more institutions to do something.''
`Hasten the Pace'
While Goldman and Morgan Stanley, both based in New York, were yesterday granted permission to transform themselves into bank holding companies, the companies so far have operated mostly under investment-bank accounting rules, logging almost $21 billion of asset writedowns and credit losses. Paulson is a former chairman and chief executive officer of Goldman.
Charlotte, North Carolina-based Bank of America, which has reported $21 billion of losses, is seeking to buy New York-based Merrill Lynch & Co., which has had $52.2 billion in losses.
Even without sales by commercial banks and savings-and-loans under the program, the companies may be harmed as the disclosure of prices paid in the troubled-debt auctions force them to ``hasten the pace'' of their own losses, Rosenberg wrote in his report. Banks and insurers mark down certain securities and derivatives to market prices in their earnings reports, avoiding losses on others unless they deem the declines to not be temporary and provisioning against loans as they go bad.
Fair Value
Bank lobbying groups today asked Congress and the U.S. Securities and Exchange Commission to suspend a rule that forces companies to put a price on difficult-to-value assets such as subprime mortgages.
``We are suggesting that the SEC issue a temporary order to negate the negative impact'' of the so-called fair-value rule when the economy slumps, Scott Talbott, senior vice president of government affairs at the Washington-based Financial Services Roundtable, said in an e-mail.
Companies including American International Group Inc., the insurer that accepted $85 billion in a U.S. takeover, have said the rule by the Financial Accounting Standards Board requires them to record losses they don't expect to incur. The world's largest banks and brokers have reported more than $520 billion in asset writedowns and credit losses since last year.
To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net.

On Wall St. as on Main St., a Problem of Denial

http://www.nytimes.com/2008/09/16/business/16nocera.html?pagewanted=2&_r=1&hp

By JOE NOCERA

Published: September 15, 2008

How can this be happening?

How can it even be possible that we wake up on a Monday morning to discover that Lehman Brothers, a firm founded in 1850, a firm that has survived the Great Depression and every market trauma before and since, is suddenly bankrupt? That Merrill Lynch, the “Thundering Herd,” is sold to Bank of America the same weekend?

Just months ago, Lehman assured investors that it had enough liquidity to weather the crisis, while Merrill raised some $15 billion over the last year to shore up its balance sheet. Now they’re both as good as gone.

Last week, it was Fannie Mae and Freddie Mac that needed a government bailout. This week, it looks as though American International Group and Washington Mutual will be on the hot seat. We have actually reached the point where there are now only two independent investment banks left: Goldman Sachs and Morgan Stanley. It boggles the mind.

But it really shouldn’t. Because after you get past the mind-numbing complexity of the derivatives that are at the heart of the current crisis, what’s going on is something we are all familiar with: denial.

Indeed, it is not all that different from what is going on in neighborhoods all over the country. Just as homeowners took out big loans and stretched themselves on the assumption that their chief asset — their home — could only go up, so did Wall Street firms borrow tens of billions of dollars to make subprime mortgage bets on the assumption that they were a sure thing.

But housing prices did drop eventually. And when people tried to sell their homes in this newly depressed market, many of them had a hard time admitting that their home wasn’t worth what they had thought it was. Their judgment has been naturally clouded by their love for their house, how much money they put into it and how much more it was worth a year ago. And even when they did drop their selling price, it never quite matched the reality of the marketplace. They’ve been in denial.

That is exactly what is happening on Wall Street. Ever since the crisis took hold last summer, most of the big firms have been a day late and dollar short in admitting that their once triple-A rated mortgage-backed securities just weren’t worth very much. And, one by one, it is killing them.

Take Richard Fuld, the chief executive of Lehman Brothers. Last summer, as the credit crisis first gripped Wall Street, Mr. Fuld’s firm, which was fundamentally a bond-trading firm, concluded that the problems would be short-lived — and that those firms willing to take big risks would be the ones that would reap the big rewards once things calmed down. So Lehman doubled down on mortgage-backed derivatives — not unlike a Florida condo owner buying a second one to flip 18 months ago.

Big mistake. Ever since then, Lehman has had a terrible time admitting the magnitude of its mistake — or properly pricing its securities. As mortgage derivatives became increasingly toxic, they also became increasingly illiquid. So firms were left to set their own “mark-to-market” price. And just like so many homeowners, they kept pricing their securities higher than they should have.

Earlier this year, for instance, when the hedge fund manager David Einhorn was making his public case against Lehman (he now refuses to talk about the firm), he stressed his belief that Lehman was valuing its securities too high. He turned out to be exactly right.

Every time the market was roiled — especially after the Bear Stearns collapse — every firm on Wall Street had to re-mark their securities to reflect the new reality. That’s why you saw firms taking billion-dollar write-off after billion-dollar write-off, long after they thought they had taken care of the problem. And it is also why the write-offs will continue now that Lehman is bankrupt.

“Selling begets more selling,” said Sean Egan of the independent bond-rating firm Egan-Jones. And yet, even as they lowered the value of their mortgage-backed securities, firms like Lehman had still priced them too high. Back when he was talking publicly about Lehman, Mr. Einhorn used to cast Lehman’s mark-to-market pricing as an act of dishonesty. I tend to think it was more like wishful thinking. Either way, the result was the same.

A week ago, even as the government was bailing out Fannie and Freddie, Mr. Fuld went off to seek new capital — something Lehman desperately needed to shore up its decimated balance sheet — from the Korea Development Bank. Why did those talks break down? Because Mr. Fuld wanted more for Lehman than the Koreans thought it was worth. He simply couldn’t face the reality that his firm wasn’t worth what he thought it was.

Published: September 15, 2008

(Page 2 of 2)

Now look at his next-door neighbor, John Thain at Merrill Lynch. To be sure, Mr. Thain owned a better house — although Merrill Lynch also had billions in toxic securities, its bread-and-butter is its brokerage arm. It is fundamentally a gatherer of assets, not a bond-trader.

But there is another big difference between the firms. Unlike Mr. Fuld, who had run Lehman since 1993 and is the architect of the modern Lehman, Mr. Thain had been at Merrill Lynch just since December, when he was brought in to stanch the bleeding. He didn’t have the same pride of ownership in Merrill that Mr. Fuld had in Lehman. That is why he was willing to sell $31 billion worth of mortgage-backed derivatives for 22 cents on the dollar in late July — far lower than many firms had been pricing those securities.

And that is also why, seeing what had happened to Bear Stearns, Fannie and Freddie, and Lehman Brothers, he took the pre-emptive step of selling Merrill Lynch to Bank of America. In the process, he got $50 billion for Merrill’s shareholders. True, that was half of what Merrill was worth a year ago, and a once-proud name is about to be swallowed up by a commercial bank. But he also got $50 billion more than Mr. Fuld got for his shareholders — and being sold is a lot better than being liquidated.

It is unlikely that the worst is over. The market Monday dropped more than 500 points, and the government is now trying to keep A.I.G. from going the way of Lehman Brothers, even asking Goldman Sachs and JPMorgan to make some $75 billion in loans available to the struggling insurance giant. And then there’s Washington Mutual. And then ... well, who knows where it will end?

Clearly the government is no longer willing to put the taxpayers’ money at risk to save firms that took on too much risk buying securities that they didn’t understand. As painful as it is to see Lehman employees lose their jobs, that is probably a good thing. That is the final parallel that exists between the housing market and Wall Street: the issue of moral hazard.

For over a year now, many Wall Streeters have complained about government efforts to forestall foreclosures, saying that it would create the expectation that everyone should be bailed out, and that consequently no one would learn important lessons about the dangers of taking more risk than they could handle. Besides, they added, the housing market was never going to improve until housing prices found their natural bottom. And that wouldn’t happen until the government stopped trying to prop up housing prices.

But in truth, you can say the same of Wall Street — it won’t learn any lessons, either, until firms that took foolhardy risks start to fail. One reason Lehman could not find a buyer over the weekend is because potential buyers were insisting on the same kind of taxpayer guarantees that the government had given JPMorgan when it bought Bear Stearns, or when it took over Fannie and Freddie. That’s the essence of moral hazard. When Treasury Secretary Henry Paulson refused to do so, the potential buyers went away.

With the government refusing to prop up Wall Street anymore, maybe now mortgage-backed derivatives will find their natural bottom. Something to look forward to, I guess.