Buffett Defends the Indefensible: Goldman Sachs and Rating Agencies; Goldman's Sweetheart Deal With Buffett Revisited

In the midst of the stock market crash, Warren Buffett got a great deal on Goldman Sachs preferreds. Those preferreds are making him $15 a second.

I do not fault Buffett one second for taking that deal. It seemed like a great deal at the time, and it was. The problem is, it's important to distinguish between a deal good for his shareholders, and the integrity of Goldman Sachs.

Sadly, Warren Buffett is now caught in no man's land, unable or unwilling to see the difference.

With that backdrop, please consider Buffett strongly defends Goldman; Berkshire net up.

Speaking at Berkshire's annual meeting, Buffett also said Berkshire swung to a $3.63 billion first-quarter profit, compared with a year-earlier $1.53 billion loss, helped by an improving economy and gains from investments and derivatives.

Buffett said he did not hold against Goldman the U.S. Securities and Exchange Commission civil fraud lawsuit alleging the bank hid from investors that securities underlying a risky debt transaction were chosen by Paulson & Co, a hedge fund firm that was betting they would lose value.

News that investigators opened a criminal probe into Goldman has led to increased speculation about Blankfein's job security, but Buffett expressed strong support.

Asked who should run Goldman if Blankfein were replaced, Buffett said: "If Lloyd had a twin brother, I would vote for him. I have never given that a thought."

The $5 billion investment consists of preferred shares that throw off $500 million in annual dividends, plus warrants to buy an equal amount of common stock. Goldman can buy back, or "call," the preferreds at a premium.

GOLDMAN, DERIVATIVES

"We love the investment," Buffett said. "Our preferreds are paying $15 a second, so as we sit here, 'Tick, tick, tick, tick,' that's $15 every second," he said.

Buffett added that the SEC lawsuit was not a serious enough event to raise reputational issues that would call into question the Berkshire investment.

That last sentence is complete nonsense at best. At worst it is a blatant lie.

Goldman's reputation most assuredly has been called into question by the SEC. Moreover, Janet Tavakoli calls it into question every day of the week. So do many others. Arguably so did the the market, judging from its reaction.

Finally, no financial company has every survived criminal fraud charges and a criminal fraud investigation is now underway.

Let's step back for a second. I never understood (until now), why Goldman Sachs would have offered Buffett the deal that it did. Anyone would have taken it. However, the deal was offered to only to Buffett.

Goldman Buys Insurance

Supposedly Goldman Sachs made that deal to calm the markets. That idea did not make much sense then and it makes even less sense now. What I do buy is the idea that Goldman bought a future favor, perhaps not even this favor, but a favor nonetheless. Consider it insurance.

Goldman's insurance policy has paid off. Goldman Sachs clearly has Buffett in its pocket.

Buffett voluntarily put himself in the position of having his integrity questioned. He could have said "we got a great deal" and left it at that. It would have been a true statement.

However, it's hard not to defend someone who give you a sweetheart deal that makes $15 a second.

Buffett Defends Rating Agencies

Inquiring minds are reading the Wall Street Journal article Buffett: Ratings Companies Still Have 'Phenomenal' Business Model

In the past year, Berkshire Hathaway has been rapidly selling shares of Moody's Corp., the ratings outfit.

But Berkshire still has a large stake in Moody's, which many say played a key role in the financial crisis by handing out high ratings to mortgage bonds that later collapsed.

Berkshire CEO Warren Buffett mounted a defense of the firms. He said he believes the ratings outfits, including Standard & Poor's, have "incredibly wonderful businesses" and that their "pricing power is significant."

That explains why he invested in Moody's. But he conceded that the firms made mistakes. "Many feel that the ratings agencies let them down," he said. "They succumbed to the same mania that prevailed throughout the investment world" when the housing market was rapidly inflating. "They couldn't see a world where residential housing countrywide would collapse," he said.

'Phenomenal' Business Model

Yes indeed, I agree with Buffett that Moody's, Fitch, and the S&P have an "incredibly wonderful businesses" in the same sense the Mafia has an "incredibly wonderful businesses" with its numbers racket.

At least with the Mafia, you know what the odds are, and profits are paid in cash.

With the rating agencies we saw blatant incompetence and fraud every step of the way. What makes that a 'Phenomenal' Business Model is explicit government sanction.

I have been harping about this since September 2007, but if you have not seen it yet, or if you need a refresher course on the business model, please see Time To Break Up The Credit Rating Cartel

Once again, I do not fault Buffet for spotting an "incredibly wonderful businesses" whose "pricing power is significant." I can and do fault Buffett for his defense of pervasive rating agency fraud, shrugging it off as a mistake.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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