Buffett's Bank of America investment is the new TARP

The risk of a bankruptcy at the nation's largest bank, or a panic by its investors or depositors, has been reduced, and by private-sector action.

By MSN Money Partner Aug 25, 2011 1:15PM

By Steve Goldstein, MarketWatch 


The Troubled Asset Relief Program may be dead, but Warren Buffett's rescue program remains intact, as Berkshire Hathaway's $5 billion investment in Bank of America (BAC) shows.


The much-maligned government plan did stabilize the financial system -- even if taxpayers are still on the hook for up to $130 billion in losses -- but private-sector bailouts are better for the public.


It's how it should be: if a private-sector bank is undercapitalized, it should find a private investor to provide an additional cushion, at a hefty price, if necessary. And that's what happened today, just a day after Buffett dreamed up the idea in his bath tub, if CNBC's account is correct.


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Of course, Buffett's been here before. Berkshire Hathaway (BRK.A) received 10%-per-year dividends by for its investments of $5 billion in Goldman Sachs (GS) and $3 billion in General Electric (GE) in late 2008, just a few days before TARP was signed into law by President Bush.


Buffett also got warrants which, in Goldman's case, are slightly underwater and in GE's case are massively so. The warrants he received from Bank of America, by contrast, are in the money as of Day One.


That doesn't mean, though, the Bank of America warrants, with a $7.14 strike price, will forever be in the money. The company reported an $8.8 billion loss in the second quarter, carries the risk of being forced to buy back billions of dollars of lousy mortgages that Countrywide underwrote, and faces increasingly tough capital standards over the next decade.


In addition, with the threat of a recession very real, provisions for credit losses could start trending the wrong way.

It is worth noting, however, that the strike price is 44% below Bank of America's tangible book value on a per-share basis, so there is a nice cushion built into the Berkshire investment.


And even if the warrants prove not to be profitable, Buffett still gets a 6%-per-year dividend, as long as the bank doesn't go belly up.


The question for investors who don't get the nearly guaranteed 6% dividend is whether it's worth following Uncle Warren in. Retail investors who followed Buffett into Goldman and GE aren't in the money, with the Connecticut conglomerate, again, the far-worse investment.


But for the economy at large, Buffett's investment is clearly good news. The risk of a bankruptcy, and just as important, a panic by either investors or depositors at America's largest bank, has been reduced. The larger question is whether more bailouts, private or public, will be needed if the economy does hit the skids.


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