The stakes were high for Buffett personally. If the bailout went through, it would be a windfall for Goldman. If it failed, it would be disastrous for Berkshire Hathaway. Buffett also had large investment stakes in Wells Fargo and U.S. Bancorp, banks that were suffering in the crisis.
The first vote failed, as Washington faced enormous heat from voters angry about the prospect of bailing out Wall Street. On the eve of a second TARP vote in the House, Buffett moved toward the fire again when he bought a $3 billion stake in corporate giant General Electric. Again, as with Goldman, he was able to negotiate advantageous terms, receiving a 10% dividend on his shares. He could also buy $3 billion in stock at discounted terms if he wanted.8 GE was in even worse financial shape than Goldman, thanks to its financial arm, GE Capital. Eventually it would need $140 billion in taxpayer capital to stay afloat.
Buffett is a genius at public relations. He said he had "confidence in Congress to do the right thing." He appeared to be a savior of Goldman Sachs and GE. He gave members of Congress more reason to join by supporting such firms.
With the passage of the Emergency Economic Stabilization Act, the Treasury Department had $700 billion to make available to financial institutions, and with it the unprecedented authority to pick winners and losers. Access to TARP money was not guaranteed. And the terms of the loans were unclear. There was no transparency and no openness to the process. As the economist Robert Kuttner put it, the TARP proceedings were "being done largely behind closed doors, and the design is by, for and in the interest of large banks, hedge funds, and private equity companies. Because there are no explicit criteria, it's very hard to know" if anyone got special treatment. The entire process, he said, "reeks of favoritism and special treatment."9
Having the correct political connections was critical, as usual. A study conducted by four researchers at the Massachusetts Institute of Technology documented the power of those connections as a general phenomenon, before the TARP program began. When Timothy Geithner was announced as President Obama's nominee for Treasury secretary, it "produced a cumulative abnormal return for Geithner-connected financial firms of around 15% from day 0." The stock market reflects the cumulative thinking of all investors, and they assumed Geithner would be able to reward his friends directly or indirectly. Conversely, when there was word that Geithner's nomination might be derailed by tax issues, those same firms were hit hard with "abnormal negative returns." The MIT researchers systematically examined firms that had corporate ties to Geithner, had executives who served with him on other boards, or had other direct relationships. According to the researchers, "The quantitative effect is comparable to standard findings" in Third World countries that had weak institutions and higher levels of corruption.10 Think of it: our markets react to these government actions the same way they do in a corrupt developing country. Crony capitalism pays, and the market knows it.
Of course Buffett was not the only one connected in Washington. Goldman Sachs also had a direct line to Treasury Secretary Hank Paulson, its former managing partner, as well as incoming officials in the Obama administration. But Buffett was far better liked by the American public than the executives at Goldman Sachs. Politically, he was a far more effective advocate for bailout funds than Paulson could ever be.
Another study, from the University of Michigan School of Business, found that "firms with political connections" were much more likely to get TARP funds than firms that were not well connected. The study looked at how much money firms contributed to election campaigns, through PAC contributions and donations by executives, as well as how much companies spent on lobbyists. Ironically, the study found that those politically connected firms actually underperformed unconnected firms despite the infusion of federal funds. In other words, poorly run, well-connected firms got the loot.11
The fact that politically connected banks got good deals from the Treasury was not lost on the banking industry. Robert Wilmers, the chairman and CEO of M&T Bank, said at the time, "The pattern is clear, the bailout money and the perks are concentrated among the big banks, the ones who pay the lobbyists and make the campaign contributions, while the healthy banks pay the freight."12
Buffett needed the TARP bailout more than most. In all, Berkshire Hathaway firms received $95 billion in bailout cash from the Troubled Asset Relief Program. Berkshire held stock in Wells Fargo, Bank of America, American Express, and Goldman Sachs, which received not only TARP money but also $130 billion in FDIC backing for their debt. All told, TARP-assisted companies constituted a whopping 30% of his entire publicly disclosed stock portfolio. As one investigation by the Houston Chronicle put it, Buffett was "one of the top beneficiaries of the banking bailout."13
Buffet demanded better terms for his Goldman investment than the government received for its bailout. His dividend was set at 10%, the government's was set at 5%. Had the bailout not gone through, and had Goldman not been given such generous terms under TARP, things would have been very different for Buffett. As it stood, the arrangement with Goldman earned Berkshire about $500 million a year in dividends. "We love the investment!" he exclaimed later to Berkshire investors. His stake in General Electric was also profitable. As Rolfe Winkler of Reuters bluntly put it, "Were it not for government bailouts, for which Buffett lobbied hard, many of his company's stock holdings would have been wiped out."14
By April 2009, share prices for Goldman had more than doubled.15 By July 2009, it was reported that Buffett had already yielded a return of $2.5 billion for his investment.
Later, astonishingly, Buffett would publicly complain about the bailouts in his annual letter to Berkshire investors, claiming that government subsidies put Berkshire at a disadvantage. As he put it, funders "who are using imaginative methods (or lobbying skills) to come under the government's umbrella—have money costs that are minimal," whereas "highly-rated companies, such as Berkshire, are experiencing borrowing costs that ... are at record levels." Berkshire, of course, is simply a holding company representing a long list of investment assets—including investments in eight banks that were helped by the FDIC's Temporary Liquidity Guarantee Program. As Winkler later put it, "It takes chutzpah to lobby for bailouts, make trades seeking to profit from them, and then complain that those doing so put you at a disadvantage."
One financial observer, Graham Summers of Phoenix Capital Research, claimed that what Buffett did was "a serious conflict of interest AND seriously bordering on insider trading."16 But what Buffett did was entirely legal. It was an exercise in crony capitalism and manipulation, but he broke no law. He simply used his political connections to secure huge profits with taxpayer money.
There are two questions to ask about this legal behavior. First, how can so many people listen to Warren Buffett's policy advice without considering how self-interested it might be? Second, and more important, how are our politics warped by deep-pocketed, heavily invested advisers?
After the bailout bill passed, Warren Buffett sat down and wrote Treasury Secretary Henry Paulson a four-page private letter proposing a larger solution to the financial crisis that would clean up the toxic assets that were plaguing so many financial institutions. Buffett came up with something he called the public-private partnership fund: a quasi-private fund backed by the U.S. government that would buy bad loans and other rapidly sinking investments. He proposed that for every $10 billion put up by the private sector, the federal government would kick in $40 billion. As Paulson put it in his memoir, "I knew, of course, that as an investor in financial institutions, including Wells Fargo and Goldman Sachs, Warren had a vested interest in the idea."17
The bootlegger's interest does not necessarily mean the Baptist's ideas are wrong. The proposal was examined by the Treasury Department, but with Henry Paulson leaving at the end of President Bush's term, it would fall to the incoming secretary, Tim Geithner, to act on it. Geithner tweaked the plan and announced it in March 2009. It was largely seen as a boon to banks, especially to large banks, which had too much bad debt.
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br /> But what did Buffett do between the time he first wrote the letter in the fall and Geithner's announcement in March? He bought more bank stocks. According to Berkshire's quarterly reports, Buffett's firm bought 12.4 million shares of Wells Fargo in this period, and another 1.5 million shares in U.S. Bancorp. When Geithner announced the Public-Private Investment Program, bank stocks rallied and Buffet's holdings did very well. We don't know the exact price that Buffett paid for these millions of shares because he is not required to list the dates he bought them in his quarterly reports. But we do know that those banking stocks all jumped after Geithner unveiled his PPIP. Wells Fargo, which was trading at around $20 per share early in 2009, jumped to $30 a share in the weeks following Geithner's announcement. U.S. Bancorp did even better. It had hit a low of $8 a share in February 2009 and jumped to more than $20 a share by May. And of course Buffett already owned tens of millions of shares in a whole host of financial stocks, such as American Express and M&T Bank, which also benefited.
He did very well with Goldman Sachs and GE too, after they received their bailout money. His net from General Electric as of April 2011 was $1.2 billion. His profits from the Goldman deal by then had exceeded the gains of July 2009, reaching as high as $3.7 billion. He was betting on his ability to help secure the bailout. The bet was a good one.18
In the fall of 2010, Buffet wrote "Thank You, Uncle Sam," an op-ed in the New York Times in which he praised the role that government played in stabilizing the markets throughout the crisis.19 There was no disclaimer or disclosure of how much he personally benefited from the TARP or the Public-Private Investment Program. He simply praised it as good public policy. At the bottom of the article he was identified in a short biography: "Warren E. Buffett is the chief executive of Berkshire Hathaway, a diversified holding company."
With tongue sarcastically in cheek, journalist Ira Stoll, the former managing editor of the New York Sun, suggested the bio might have been more accurate with a bit of rewriting: "Warren Buffett, the largest crony capitalist in the world, shareholder of GE, Goldman Sachs, Wells Fargo, US Bancorp, M&T Bank, and American Express, as well as competitor of private equity and hedge fund firms that have been threatened with new taxes and regulations, and behind the scenes, insider adviser to most of the government officials mentioned above."20
Again, to be clear, even though Buffet was the one who proposed the public-private partnership, there is absolutely nothing illegal about lobbying for a policy while investing in the potential winners if that policy is adopted. But consider this: had Buffet been pushing a private investment house to make an acquisition that would benefit certain stocks while quietly buying shares in those same stocks, he would possibly have been investigated for insider trading. Indeed, this is what his lieutenant David Sokol was accused of doing, landing him in legal hot water. Sokol apparently bought shares in Lubrizol, a chemical company, and then encouraged his employer, Berkshire Hathaway, to buy a large stake in the company, thereby driving up the price of the stock.21 All Buffett did differently was use the federal government instead of a private company to boost the prices of certain stocks. This, of course, is why crony capitalism is so attractive to financiers. First, it's legal. Moreover, it is often more remunerative than the illegal private-sector version might be. Because government officials are dealing with other people's money, they are less likely to drive a hard bargain than a private firm would.
Buffett has long been a believer that corporate-government partnerships are investment opportunities. While Buffett is famous for owning Dairy Queen and other all-American private companies, two of his largest holdings are in railroads and regulated utilities. He regularly lobbies for and counts on significant public money to make them more profitable.
After the financial crisis in the fall of 2008 appeared to be easing, Buffett turned his attention to championing the stimulus program for the Obama administration. When he went on television to proclaim his support for a stimulus, he was never asked what he might get out of the deal. A candid answer would have taken up many valuable minutes of airtime.
In late 2009, Buffett made his largest investment ever when he decided to buy Burlington Northern Santa Fe Railway (BNSF). It was not just a bet on the financials of the railroad industry; it was also a huge bet on his friend President Obama's budget priorities. As the Wall Street Journal reported, "Berkshire Hathaway Inc.'s planned purchase of Burlington Northern Santa Fe Corp. represents a bet that upcoming Washington policies to improve infrastructure and combat climate change will be a boon to the freight-railroad industry. President Barack Obama has said railroad investment will be a cornerstone of his transportation policies, given the environmental benefits and improved mobility that come with taking cars and trucks off roads."22
Others in the railroad industry saw Buffett's involvement as very helpful, precisely because he was so politically connected. "It's a positive for the rail industry because of Buffett's influence in Washington," explained Henry Lampe, president of the Chicago South Shore & South Bend, a short-haul railroad.23
Buffett bought the BNSF just as the Obama administration was beginning a series of initiatives to rapidly expand the government's commitment to spending on railroads.24 After Buffett took over the company, he dramatically increased spending on lobbyists. Berkshire spent $1.2 million on lobbyists in 2008, but by 2009 its budget jumped to $9.8 million, where it has generally remained. Pouring money into lobbying is perhaps the best investment that Buffett could make.25
President Obama's plans to invest heavily in railroads, including a commitment to high-speed rail, position BNSF to benefit handsomely. In the Seattle area there have already been discussions between local officials and BNSF about either leasing or selling its rail lines for an intercity project. And that's just the start. A map of the BNSF lines around the country overlaps nicely with the government's proposed high-speed rail lines, from Seattle to Florida, California to the Northeast. Buffett is geographically and strategically positioned to profit from those government-funded rail systems, should they be built.
All together, in the stimulus package created in 2009, the federal government set aside $48 billion (of the total $787 billion) for infrastructure improvement, some of which goes to railroads. How much will BNSF benefit? It's nearly impossible to calculate. Type BNSF on the Recovery.gov website, which tracks grants, subsidized loans, and contracts signed under the stimulus, and you find 1,800 entries, including everything from $36 million grants from the Department of Homeland Security to money from the Environmental Protection Agency.
Buffett also owns MidAmerican Energy Holdings, which received $93.4 million in stimulus money. General Electric, of which he owns a $5 billion stake, was one of the largest recipients of stimulus money in the country.
As Buffett often does, he puts his ideas in down-home terms in his famous annual letter to Berkshire investors. He doesn't mention lobbyists, government funds, bailouts, or stimulus grants. "We see a 'social compact' existing between the public and our railroad business, just as it is the case with our utilities," he said in his 2010 annual letter to shareholders. "If either side shirks its obligations, both sides will inevitably suffer. Therefore, both parties to the compact should—and we believe will—understand the benefit of behaving in a way that encourages good behavior by the other. It is inconceivable that our country will realize anything close to its full economic potential without it possessing first-class electricity and railroad systems." He further noted that both businesses "require wise regulators who will provide certainty about allowable returns so that we can confidently make the huge investments required to maintain, replace, and expand the plant."
The term "social compact" sounds benign. But when did American voters make a compact to turn one of the richest men in America into one of the biggest recipients of taxpayer subsidies?
In August 2011, Buffett vacationed with President Obama on Martha's Vineyard and they discussed the economy. Shortly after that, he agreed to host an Obama reel
ection fundraiser in New York City, for which contributors could buy VIP tickets for $35,800 to meet Buffett and talk about the economy.26
It has long been known to be Warren Buffett's style to base major financial decisions on a few phone calls. As fellow investor Steven Rattner pointed out, "Warren Buffett has shown that superb investing need not entail the months of due diligence and deliberation that private equity firms typically apply to a deal. Buffett has been known to make successful multibillion-dollar bets on the basis of a few meetings or phone calls."27 That is particularly true if those phone calls are going to Washington.
Warren Buffett is a financial genius. But even more important for his portfolio, he's a political genius.
7. CRONIES ON PARADE: HEDGE FUNDS, DEFENSE CONTRACTORS, COLLEGES, BIG OIL...AND GEORGE SOROS
MOST CAPITALIST CRONIES are neither Baptists nor bootleggers. They do nothing illegal, but neither do they claim to be holy. Instead, they quietly lobby Congress, and their fortunes rise and fall on policy decisions rather than market competition. In this chapter, we will consider a wide range of examples, from finance to manufacturing to education.
Perhaps the best investment a hedge fund can make these days is not in a financial wizard but a politician. Hedge funds and financiers are becoming more political than ever before. And political figures and government appointees with no background in finance (former Vice Presidents Dan Quayle and Al Gore, and former Secretary of State Madeleine Albright, for example) have launched their own investment funds. "The former politician/investment guru fraternity appears to be growing," noted one industry observer.1 And former politicians are finding a career that can be even more lucrative than lobbying: providing "political intelligence" to investment funds, based on private conversations with congressional staffers and sitting senators.
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