Street Capitalist: Event Driven Value Investments

While Warren Buffett of Berkshire Hathaway (NYSE:BRK.A) has mostly come out with praise for Henry Paulson’s bailout plan, he has reserved some criticism aimed at the “hold-to-maturity” price that tax payers would be footing the bill for:

JOE: It’s just that, you know, they want these details, Warren. They said — Paulson says there’s the hold-to-maturity price and there’s the firesale price. We’re going to go somewhere in between, get a much better price but still leave enough for the people that are buying it to make some money. That can be done in principle? There’s a way to do that, do you think?

BUFFETT: I think what I would be looking for -- I heard that hold-to-maturity price. I’m not as excited about that. I basically like a market, or something very close to a market-related price. And there are ways to determine that and I don’t think that Uncle Sam should be in the business of paying somebody a whole lot more than it’s worth in the market today. And if the guy that bought it doesn’t like it, he doesn’t have to sell it, and it was his problem, he bought it in the first place. I think a market price will enable people to be leveraged. The problem they have now is that some of the institutions, they’re loaded with this stuff, they’re having trouble funding, and they’re worried about being able to sell a ton of it. But take the Merrill Lynch deal. Merrill Lynch had to take back 75 percent of the sales price. Well, they didn’t want to take back that 75 percent. I would let ‘em sell it for the same price, but I’d pay them the whole thing in cash. So they’d be a lot better off if they could have sold the whole thing at that same price but gotten paid a hundred percent in cash instead of having to take back 75 percent. And I see the government fulfilling that kind of a function.

CNBC INTERVIEW TRANSCRIPT & VIDEO, Part 3: Warren Buffett Explains His $5B Goldman Investment (CNBC)

We know that Buffett announced his investment in Goldman Sachs (NYSE:GS) shortly after details about the bailout plan actually emerged. It’s easy to see why. The government would be purchasing the cancerous toxic assets that have infected financial institutions and forced them to write down their values. Buying these assets at fire sale prices makes sense, even Buffett thinks that there may be opportunities in this area and on CNBC expressed that he would love to have $700 billion to go buy them up.

Unfortunately though, fire sale and hold-to-maturity prices are quite different and are likely to be spread vastly apart. It’s simple to see why he’s not enthusiastic about this aspect of the bailout plan. Warren Buffett is a value investor, he hunts for bargains. Bargain hunting means investing in securities with a sufficient margin of safety or the spread between what a security is selling for and its intrinsic value. Investors usually wish to find wide margins of safety in case something unintended happens, perhaps a problem grows worse than you expect or that you overlooked some aspect of the company your analysis.

The lack of market prices reduces any margin of safety that the government could obtain on these assets and puts taxpayer money at risk for losses. The folks in Washington should try to do something to avoid it. So far, Congress seems to be resisting Paulson’s plan and may have some room to make modifications. They seem to be fighting for basically a few added options - equity stakes in the companies that are bailed out, market pricing, and curbed executive pay. I can see the merits in the first two, equity stakes would provide the government with an upside when bailing out these financial firms. After all, once those toxic assets are taken away many of these companies have nice businesses.

I feel like the executive pay idea is a little too rhetorical and may be too small of a problem when compared to everything else Congress has to worry about. Plus there is the added risk that Congress would waste taxpayer money on the hiring of compensation consultants to tackle the problem which brings to mind a funny quote by Charlie Munger- “I would rather throw a viper down my shirtfront than hire a compensation consultant.”