It's not even a week old, and Warren Buffett's deal to invest $5 billion of Berkshire Hathaway's money in Bank of America has already been dissected, parsed, praised, and even criticized. This isn't surprising, of course. Every word that passes Buffett's lips and every move he makes get scrutinized. Part of the fascination with Buffett is simply that he's one of the richest men in the country. But another part of it is the notion that the means by which he made his fortune—his investing prowess—is something that can be replicated by ordinary people. All we have to do is watch and listen, and we'll absorb the magic.
Bethany McLean is a contributing editor at Vanity Fair and the co-author of All the Devils Are Here: The Hidden History of the Financial Crisis.
Bethany McLean writes a weekly business column for Slate and is a contributing editor to Vanity Fair. She is the author (with Joe Nocera) of All the Devils Are Here: The Hidden History of the Financial Crisis and (with Peter Elkind) "The Smartest Guys In The Room."
Buffett is one of the greatest investors in history, and you can learn a lot by looking at his older investments. But some of Buffett's recent deals follow a different model than his investments of the '70s, '80s, and '90s. The Bank of America deal is actually a case study in why the rest of us can't invest like Warren Buffett.
For starters, Buffett has access that ordinary investors can only dream of having. The genesis of the Bank of America deal was a phone call from Buffett's assistant to the office of BofA CEO Brian Moynihan last Wednesday. Moynihan, of course, took the call, and Buffett offered to make the investment. Your average Bank of America shareholder would be lucky to speak to Brian Moynihan's assistant's assistant.
Next, consider the structure of the deal. This isn't an ordinary investment, in which an investor buys common stock. Buffett's $5 billion is buying him 50,000 shares of a special class of so-called "preferred stock," which will pay him a 6 percent dividend, or $300 million a year. Just for the sake of comparison, BofA's common shareholders get a quarterly dividend of one penny a share. That means that if you owned $5 billion of ordinary BofA common stock at its current price of about $8 a share, you'd be getting a paltry $25 million a year in dividends—less than one-tenth of what Buffett will get. (Earlier this year, BofA tried and failed to get permission from the Federal Reserve to increase the dividend.)
BofA can buy back Buffett's investment at any time for a 5 percent premium.
In fairness, you could get a bigger dividend by buying BofA's preferred stock. But you couldn't get the best part of Buffett's deal, which are the warrants. These give Berkshire the right to buy 700 million shares of BofA stock at $7.14 a share at any time over the next 10 years. Warrants are usually issued at a substantial premium to the issuer's stock price, but Buffett's were issued at only a tiny premium to BofA's closing price last Wednesday. There are lots of ways to think about how much these warrants are worth, but most analysts and observers pegged the value at somewhere around $3 billion. Yes, that's $3 billion that BofA handed Buffett, gratis. You try getting that deal!
Finally, you can't invest like Buffett because your investment, unlike his, is not a self-fulfilling prophecy. Because Buffett invests, others believe. When the news broke about his investment in BofA, the stock immediately shot up more than 25 percent. It closed the day up 9 percent. On Monday, which was a huge up day for the overall market, BofA closed 20 percent from its Wednesday pre-deal price. At this writing, BofA is about $8.15 per share, which means the value of his warrants has soared, at least partly because of his investment. Wouldn't it be nice if our money made money, too?
The BofA deal isn't the first time Buffett has done a deal like this. His $5 billion in Goldman Sachs at the height of the financial crisis was similar. That deal, not incidentally, was a home run for Buffett's Berkshire Hathaway. Goldman paid Berkshire more than $1 billion in dividends—more than $1 million a day—and this spring, Goldman redeemed Berkshire Hathaway's shares for $5.5 billion. (Buffett still has warrants to buy Goldman shares at $115 a share, which were worth a lot before the slide in the market and may be worth a lot again before they expire in 2013.) Buffett also struck a similar deal with General Electric.
It's not surprising that Buffett's BofA investment has generated the criticism that followed his Goldman and GE deals. The first part of the criticism is that Buffett is profiting from the implicit taxpayer guarantee that supports all too-big-to-fail institutions, Goldman, GE, and BofA included. The other part of the criticism is that Buffett is no longer so much a great investor as he is a very privileged one who gets deals the rest of us can't.
The first part of the criticism is legitimate—although you or I could also buy shares in a financial institution and benefit from that taxpayer guarantee, too. As for the second part, there's another way to look at it, which is that Buffett has earned the right to get sweetheart deals. After all, when Warren Buffett invests in a company, he is conferring upon that company something very unique: his credibility. No average investor—in fact, no other investor anywhere—can do that to the same degree. Just check out what happened to BofA's stock after a well-regarded investor named Bruce Berkowitz put both his money and his mouth behind the bank. The stock continued to slide. In other words, if Buffett can give a company something that no ordinary investor can, then maybe he should be paid like no ordinary investor.
And if that doesn't make you feel better, I have another suggestion: Buy a few shares of Berkshire Hathaway.