"Confidence - Buffett Helps, But Still Missing in Washington"

Sydney M. Williams

Thought of the Day

“Confidence – Buffett Helps, But Still Missing in Washington”

August 26, 2011

Mr. Bernanke will speak this morning from the beautiful peaks of Jackson Hole to a depressed Main and Wall Street – already skittish about sending good money chasing bad – who are now, at least on the East Coast, bracing for the unwelcome arrival of Irene.

With rates as low as they are, it seems to this uneducated observer than any further easing would be equivalent to pushing on a string. Bank liquidity is not the problem it was in 2008. Corporations are sitting on mounds of cash – an estimated $1.2 trillion. It has been uncertainty that has kept that cash from being invested. With three dissenters at the last Fed meeting, it seems unlikely that Mr. Bernanke will implement a QE 3, but one never knows. However, the Fed could certainly stop paying interest on the excess reserves that banks have housed at the Fed. Those reserves amount to about $1.6 trillion and provide little value to the economy sitting where they sit. The cessation of paying interest by the Fed would incentivize banks to more aggressively increase their loan portfolios.

After the Labor Day holiday the President plans to speak to the nation about his plan to “pivot to jobs.” Does that suggest that jobs have not been in the forefront of his concerns? That’s hard to believe. He has constantly spoken of the need for more jobs. The problem has been that his announced policies have had the effect of reducing confidence among small business owners – the engines of job growth in our economy. Mortimer Zuckerman, in an op-ed in yesterday’s Wall Street Journal, wrote that there are “fewer Americans working full time today than when Mr. Obama took office.” If the President’s speech is going to have a meaningful economic impact he will have to “pivot” from past policies of increased regulation (including healthcare) to one of encouraging government to step out of the way and let business operate more freely – a very unlikely prospect. His words assuredly will be eloquent, but it will be the substance of those words that ultimately will be important.

On the other hand, Warren Buffett’s decision yesterday to invest $5 billion in a Cumulative Perpetual Preferred Stock of Bank of America represented a measure confidence the bank needed. For his investment he receives a six percent coupon, in equal quarterly payments and 10-year warrants to purchase 700,000 shares of common stock at an exercise price of $7.142857. The bank retains the right to redeem the preferred at any time at a five percent premium. I have no ability to determine the financial condition of any bank, let alone a bank as complex as Bank of America. However, the price of Bank of America declined 24% between August 1st and the 24th. That decline came amidst growing rumors as to the weakness of the bank. Unfortunately with a bank, a declining stock price can become a self fulfilling prophecy. The bank’s equity declines, their cost of capital rises and depositors start pulling money out. Confidence withers. Mr. Buffett is able to command generous terms because of the combination of his reputation and pocket book and the times when he chooses to invest.

It is easy to criticize Mr. Buffett for the terms he is able to extort, but investors should consider the alternative. Would the financial system be better off if Bank of America failed? Mr. Buffett’s investment is no guaranty that Bank of America will not fail, but it is a vote of confidence. And the world’s commercial, banking and credit systems are based on confidence. What lifts confidence is good; what lowers it is bad.






Sydney M. Williams

Thought of the Day

“Confidence – Buffett Helps, But Still Missing in Washington”

August 26, 2011

Mr. Bernanke will speak this morning from the beautiful peaks of Jackson Hole to a depressed Main and Wall Street – already skittish about sending good money chasing bad – who are now, at least on the East Coast, bracing for the unwelcome arrival of Irene.

With rates as low as they are, it seems to this uneducated observer than any further easing would be equivalent to pushing on a string. Bank liquidity is not the problem it was in 2008. Corporations are sitting on mounds of cash – an estimated $1.2 trillion. It has been uncertainty that has kept that cash from being invested. With three dissenters at the last Fed meeting, it seems unlikely that Mr. Bernanke will implement a QE 3, but one never knows. However, the Fed could certainly stop paying interest on the excess reserves that banks have housed at the Fed. Those reserves amount to about $1.6 trillion and provide little value to the economy sitting where they sit. The cessation of paying interest by the Fed would incentivize banks to more aggressively increase their loan portfolios.

After the Labor Day holiday the President plans to speak to the nation about his plan to “pivot to jobs.” Does that suggest that jobs have not been in the forefront of his concerns? That’s hard to believe. He has constantly spoken of the need for more jobs. The problem has been that his announced policies have had the effect of reducing confidence among small business owners – the engines of job growth in our economy. Mortimer Zuckerman, in an op-ed in yesterday’s Wall Street Journal, wrote that there are “fewer Americans working full time today than when Mr. Obama took office.” If the President’s speech is going to have a meaningful economic impact he will have to “pivot” from past policies of increased regulation (including healthcare) to one of encouraging government to step out of the way and let business operate more freely – a very unlikely prospect. His words assuredly will be eloquent, but it will be the substance of those words that ultimately will be important.

On the other hand, Warren Buffett’s decision yesterday to invest $5 billion in a Cumulative Perpetual Preferred Stock of Bank of America represented a measure confidence the bank needed. For his investment he receives a six percent coupon, in equal quarterly payments and 10-year warrants to purchase 700,000 shares of common stock at an exercise price of $7.142857. The bank retains the right to redeem the preferred at any time at a five percent premium. I have no ability to determine the financial condition of any bank, let alone a bank as complex as Bank of America. However, the price of Bank of America declined 24% between August 1st and the 24th. That decline came amidst growing rumors as to the weakness of the bank. Unfortunately with a bank, a declining stock price can become a self fulfilling prophecy. The bank’s equity declines, their cost of capital rises and depositors start pulling money out. Confidence withers. Mr. Buffett is able to command generous terms because of the combination of his reputation and pocket book and the times when he chooses to invest.

It is easy to criticize Mr. Buffett for the terms he is able to extort, but investors should consider the alternative. Would the financial system be better off if Bank of America failed? Mr. Buffett’s investment is no guaranty that Bank of America will not fail, but it is a vote of confidence. And the world’s commercial, banking and credit systems are based on confidence. What lifts confidence is good; what lowers it is bad.