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Friday, August 26, 2011

Banking on Buffett’s Bank

Beyond wondering what could Ken Lewis have been thinking when he ok’d Bank of America’s purchase of Countrywide, it might be worth pondering why the Dodd-Frank Financial Reform Law of 2010 did not mandate splitting up banks such as Bank of America, which with over $1 trillion in assets are too big to fail. In other words, is simply increasing their reserve requirements tantamount to gambling with the financial system in a reckless manner? Should the elected representatives of the people and the states in the U.S. House and U.S. Senate, respectively, have displayed more fortitude in resisting the banking lobbyists even when that industry was known to have been culpable in the 2008 credit crisis?

The risk still remaining in August 2011 was evident when Bank of America’s stock price went down to $6. According to the New York Times, “the speed of the descent and the surge in the cost of insuring the company’s debt awakened memories of the financial crisis, when companies like Bear Stearns and Lehman Brothers found themselves short of capital.” To be sure, BOA’s capital held at $218 billion at the end of June 2011 by one key measure, though some investors did not trust the bank’s numbers. Of course, when there is a run on a bank, a capital figure is almost irrelevant, as are claims that additional capital are not necessary. Fortunately, Warren Buffett ignored such an asseveration from Brian Moynihan, the bank’s $9 billion loss over the previous 18 months, and the bank’s increased reserves ($18 billion from $4billion in January 2010) for investors of soured CDOs. Not wasting time scheduling a meeting with Moynihan, Buffett went to the board and soon had a deal wherein the investor would put down $5 billion in exchange for preferred stock paying a guaranteed 6% annual dividend and warrants good for ten years for 700 million shares. Like Buffett’s $5 billion deal with Goldman Sachs, which netted the investor over $1 billion as of mid-2011, the BOA deal looks like a money-maker for him. In exchange, the bank gets a huge vote of confidence, which regardless of any capital needs, was of great value to the bank (as the other deal had been to Goldman even though that bank had not yet needed $5 billion in additional capital).

Tossing around $5 billion to Goldman (and $3 billion to GE, which had been relying on the repo market) and $5 billion more three years later—in both cases to buttress a bank too big to fail—ought to make clear to the rest of us that merely allowing the $1 trillion club of banks to continue to exist is itself of such systemic risk that high stakes gambling is necessary to avoid catastrophe. My point is that through our elected representatives, the American electorate has a choice; we need not accept the presupposition that economic liberty requires that even banks whose very existence represents systemic risk have a right to continue to operate as going concerns. To put it differently, Warren Buffett was 80 years old when he put together the BOA deal.

Isn’t there something precarious about an empire the size of the U.S. relying on an old man to keep a major bank from imploding due to the financial fallout stemming from a stupid decision to acquire a mortgage servicer on steroids? Had anyone from BOA bothered to do what Larry McDonald did while he was at Lehman—Dick Fuld’s Lehman for Christ’s Sake!—namely, simply going a restaurant near Countrywide’s headquarters in California to chat at lunchtime with a few of the many brainless salesmen wearing gold watches and driving new sports cars bought from the double commissions on the known-to-be junk mortgages—BOA’s managers and board would (hopefully) never have agreed to ingest the leprosy, let alone play with it and touch it. Strangely, Ken Lewis had a reputation at the time as an expert on M&A; after all, that is how he had expanded BOA. Nevertheless, Lewis on Countrywide seems a lot to me like Lee at Gettysburg (what could possibly been in the confederate general’s head as he disregarded Longstreet’s objections to Pickett’s charge?—Lee might as well have used a firing squad on the division and saved the Union army the trouble). I think we are too enamored with authority that comes with position, whether in corporations, government or religion.

In summary, relying on one rich old man to prevent the financial system from imploding from the demise of a bloated, misguided bank like BOA does not sound very prudent to me. We might as well make every American city into Las Vegas and paint the towns red. Forgive me but I have to ask, Do we really know what we’re doing, folks? Minding the store might mean slapping some hands (or worse) when our elected representatives get to playing too much with the self-absorbed banking lobby.


Nelson D. Schwartz, “Buffett to Invest $5 Billion in Shaky Bank of America,” New York Times, August 26, 2011. http://www.nytimes.com/2011/08/26/business/buffett-to-invest-5-billion-in-shaky-bank-of-america.html

Ben Protess and Susanne Craig, “Buffett’s Bank of America Stake Viewed as a Seal of Approval,” New York Times, August 26, 2011.