Buffett Sacks Goldman

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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While Ben Bernanke and Hank Paulson were making the case before Congress on Tuesday as to why the free markets can't work in the current credit crisis and how only a nationalized banking system can save the day (the early communists would have been proud), the man who knows more than anyone about how to make money was showing them up for the buffoons that they are. Warren Buffett provided Goldman Sachs with some desperately needed cash, and in return he got one of the good deals that he is famous for. Buffett's move is only the beginning of the big money cashing in big time if the bank bailout goes through.

Goldman Sachs became a more desirable holding for Buffett over the weekend when it, along with Morgan Stanley, became a commercial bank. With this action the era of free standing investment banks was over. The era began in 1933 when the Glass-Steagall Act forbade U.S. banks to engage in both commercial and investment banking activities. The intention of this legislation was to prevent a return of the credit crisis that caused the Great Depression in the 1930s. After most other Depression era banking reforms had already been removed over the years, the Gramm-Leach-Bliley Act repealed Glass-Steagall in 1999. The credit crisis we are now experiencing, which rivals the one that took place in the 1930s, began only seven years later. Only five major independent investment banks still existed at its inception. Then Bears Stearns was forcibly acquired by JP Morgan when it folded in March and this month, Lehman declared bankruptcy and Bank America took over Merrill Lynch. Goldman and Morgan Stanley have now added commercial banking. They will be subject to additional regulation, but can participate fully in the Fed's entire range of funding largess for commercial banks.

The deal for Buffett is not only lucrative, but is almost as can't lose as you can get. In exchange for his $5 billion cash infusion, Buffet is getting preferred stock with a 10% dividend and calls for up to 9% of Goldman stock with a strike price of $115 and an expiration date five years from now (Goldman closed at $125.04 the day of the deal). Goldman can buy back the preferred at any time at a 10% premium to Buffet's purchase price. So if things turn around soon, Buffet would make a quick 10% and even more on his options on Goldman's stock (which he gets to keep until he converts them). Buffett is also reasonably assuming that whatever form the bailout bill takes, Goldman will be at the top of the list of its beneficiaries if Paulson has anything to do with it.

The Buffett deal is not something the average investor could ever get. It is a great example of how the more capital you have, the greater returns you can make. It also highlights how the U.S government is instrumental in both creating and maintaining wealth for favored corporations and individuals. Buffett is merely taking advantage of the banking bailout in the works. While it may be the most blatant example ever of cronyism and corporate socialism in our history, it's not the first time that 'too rich to fail' has been U.S. policy.

NEXT: Pinnochio's Reflection in Washington's Crytal Ball

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.