Government Settles for Worse Credits and Terms that Warren Buffett

The latest financial rescue package is centered around a direct government investment of $250 billion, half of which will go in 9 major banks.

Hank Paulson sat down yesterday with the heads of the 9 major banks - Kenneth D. Lewis of Bank of America, Jamie Dimon of JPMorgan Chase, Lloyd C. Blankfein of Goldman Sachs, John J. Mack of Morgan Stanley, Vikram S. Pandit of Citigroup, Robert Kelly of Bank of New York Mellon and John A. Thain of Merrill Lynch - and explained that the US government is making an investment in their companies for the good of the country's and world's economy and that they would need to accept it.

The terms are now disclosed. The US government is buying preferred equity with a preferred dividend of 5% over 5 years, rising to 9% after 5 years. The government also gets warrants in the amount of 15% of the total amount invested as preferred preferred equity with a strike price set at the average stock over the past 20 days, as of today.

The terms of the government's preferred invvestment are substantially worse than those on which Warren Buffett and Berkshire Hathaway invested in Goldman and GE. Buffett got at least a 10% dividend, plus a 10% boost on GE if Berkshire's investment is redeemed after 3 years. The credits are clearly much worse than the GE and Goldman credits that Buffett got (GE is still triple-A)

Buffett got more warrants in purportion to his investment principal, and all of them were in the money on the date of investment (they did all briefly go out of the money at the end of last week). It is unclear whether the government's warrants are in the money or out of the money, but I suspect that at least with regard to Bank of America / Merrill Lynch and Morgan Stanley, they are in fact way out of the money.

You would think that Paulson could have negotiated a better deal for us. I'd rather be a shareholder in Berkshire Hathaway than a US taxpayer!

Jason Rodgers
Jason Rodgers: Jason Rodgers was an experienced research analyst for a major bank prior to retiring to run his own investment consultancy in beautiful Lihue, Hawaii. Jason contributed articles to BestCashCow from 2008 to 2014.

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