Rolfe Winkler

Charging a bank for an implicit government guarantee to absorb losses? According to the Wall Street Journal, the Federal Reserve and Treasury are demanding that Bank of America pay $500 million to exit a bailout deal that was never actually signed.

That’s a nice chunk of change, but taxpayers shouldn’t be fooled into thinking this — or any other bailout — is a good deal.

A very dangerous misconception is taking root in the press, that in addition to saving the world financial system, the bank bailout is making taxpayers money.

“As big banks repay bailout, U.S. sees profit” read the headline in the New York Times on Monday. The story was parroted on evening newscasts.

The trouble is the popular view that TARP was the bailout. That very unpopular $700 billion program got all the attention because it was an easy story to tell a general audience. It had a big ugly price tag; it was debated very publicly in Congress; and, most important, the list of recipients and their take was made public all at once.

So when those recipients pay back TARP — at a decent profit for taxpayers — bailouts all of a sudden don’t seem so bad.

But the bailout was much larger than TARP. There is FDIC’s debt guarantee program, which still backs over $300 billion worth of financial sector debt; there are the Federal Reserve’s emerging lending facilities, which have showered hundreds of billions of cash on banks in exchange for, well, we don’t know what. There was the AIG bailout, which gave the company tens of billions more. There were changes in fair value accounting rules, which permitted banks to hide losses, and there is stupendous support for the housing market, which has rescued banks from huge write-offs.

All of these and more make up the implicit too-big-to-fail guarantee that the biggest financials have all received. The total cost won’t be known for years, and the price tag is likely to be enormous.

Look no further than Fannie Mae and Freddie Mac. The moral of their story is that implicit guarantees alter the investment landscape in ways that are very destructive and, ultimately, very expensive.

Portfolio managers kept buying Fan and Fred backed mortgage paper even after the companies’ capital structures had deteriorated significantly. They didn’t care about fundamentals because they were buying a government guarantee.

But eventually the bill comes due. In Fannie’s and Freddie’s case, taxpayers have promised $400 billion to absorb losses.

Instead of learning from that mistake, policy-makers thought it wise to repeat it on a larger scale, backing not just the housing market, but most of the financial sector, too.

The $500 million that the Fed and Treasury could collect from Bank of America is a nice token sum. But it doesn’t begin to pay the cost of BofA’s implicit guarantee against failure.

Taxpayers should keep that in mind whenever they see misguided reports that they are making money from bailouts. The truth is that the biggest banks are still insolvent and, ultimately, their losses are likely to be absorbed by taxpayers.

When I was 14, Warren Buffett wrote me a letter.

It was a response to one I’d sent him, pitching an investment idea.  For a kid interested in learning stocks, Buffett was a great role model.  His investing style — diligent security analysis, finding competent management, patience — was immediately appealing.

Buffett was kind enough to respond to my letter, thanking me for it and inviting me to his company’s annual meeting.  I was hooked.  Today, Buffett remains famous for investing The Right Way.  He even has a television cartoon in the works, which will groom the next generation of acolytes.

But it turns out much of the story is fiction.  A good chunk of his fortune is dependent on taxpayer largess. Were it not for government bailouts, for which Buffett lobbied hard, many of his company’s stock holdings would have been wiped out.

Berkshire Hathaway, in which Buffett owns 27 percent, according to a recent proxy filing, has more than $26 billion invested in eight financial companies that have received bailout money.  The TARP at one point had nearly $100 billion invested in these companies and, according to new data released by Thomson Reuters, FDIC backs more than $130 billion of their debt.

To put that in perspective, 75 percent of the debt these companies have issued since late November has come with a federal guarantee. (Click chart to enlarge in new window)

Without FDIC’s debt guarantee program, even impregnable Goldman would have collapsed.

And this excludes the emergency, opaque lending facilities from the Federal Reserve that also helped rescue the big banks. Without all these bailouts, the financial system would have been forced to recapitalize itself.

Banks that couldn’t finance their balance sheets would have sold toxic assets at market prices, and the losses would have wiped out their shareholder’s equity.  With $7 billion at stake, Buffett is one of the biggest of these shareholders.

He even traded the bailout, seeking morally hazardous profits in preferred stock and warrants of Goldman and GE because he had “confidence in Congress to do the right thing” — to rescue shareholders in too-big-to-fail financials from the losses that were rightfully theirs to absorb.

Keeping this in mind, I was struck by Buffett’s letter to Berkshire shareholders this year:

“Funders that have access to any sort of government guarantee — banks with FDIC-insured deposits, large entities with commercial paper now backed by the Federal Reserve, and others who are using imaginative methods (or lobbying skills) to come under the government’s umbrella — have money costs that are minimal,” he wrote.

“Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that … are at record levels. Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be.”

It takes remarkable chutzpah to lobby for bailouts, make trades seeking to profit from them, and then complain that those doing so put you at a disadvantage.

Elsewhere in his letter he laments “atrocious sales practices” in the financial industry, holding up Berkshire subsidiary Clayton Homes as a model of lending rectitude.

Conveniently, he neglects to mention Wells Fargo’s toxic book of home equity loans, American Express’ exploding charge-offs, GE Capital’s awful balance sheet, Bank of America’s disastrous acquisitions of Countrywide and Merrill Lynch, and Goldman Sachs’ reckless trading practices.

And what of Moody’s, the credit-rating agency that enabled lending excesses Buffett criticizes, and in which he’s held a major stake for years?  Recently Berkshire cut its stake to 16 percent from 20 percent.  Publicly, however, the Oracle of Omaha has been silent.

This is remarkably incongruous for the world’s most famous financial straight-shooter. Few have called him on it, though one notable exception was a good article by Charles Piller in the Sacramento Bee earlier this year.

Buffett didn’t respond to my email seeking a comment.

What saddens me is that Buffett is uniquely positioned to lobby for better public policy, but he’s chosen to spend his considerable political capital protecting his own holdings.

If we learn one lesson from this episode, it’s that banks should carry substantially more capital than may be necessary.  You would think Buffett would agree. He has always emphasized investing with a “margin of safety” — so why shouldn’t banks lend with one?

Yet he mocked Tim Geithner’s stress tests, which forced banks to replenish their capital. Why? Is it because his banks are drastically undercapitalized?  The more capital they’re forced to raise, the more his stake is diluted.

He points to Wells Fargo’s deposit funding model being more robust than investment banks’, but that’s no excuse for letting tangible equity dwindle to three percent of assets.  At that low level, the capital structure would have collapsed were it not for bailouts.

And by the way, the strength of Wells’ funding model is a result of FDIC insurance, among the government subsidies Buffett complains about in this year’s letter.

To me this feels like a betrayal.  There’s a reason he’s Warren Buffett and not, say, Carl Icahn.

As Roger Lowenstein wrote in his 1995 biography of Buffett, “Wall Street’s modern financiers got rich by exploiting their control of the public’s money … Buffett shunned this game … In effect, he rediscovered the art of pure capitalism — a cold-blooded sport, but a fair one.”

But there’s nothing fair about Buffett getting a bailout, about exploiting the taxpaying public for his own gain.  The naïve 14-year-olds among us thought he was better than this.

What would Ben Graham say?

Rs and Ds in the Senate have agreed on the basic framework for a new housing bill, according to the NYT. The basic framework appears to include the follwing:

• $100 million to expand counseling for homeowners at risk of defaulting on their loans
• tax-exempt bonds to let local housing agencies refinance subprime mortgages
• $4 billion in grants for local governments to buy foreclosed properties
• several tax provisions, including a credit of $7000 for purchasers of foreclosed properties that have been sitting vacant, and a break for struggling home-builders, allowing them to claim current losses against taxes paid in earlier, more profitable years
• a cap on mortgages insured by the Federal Housing Administration at $550,000 in the most expensive real estate markets. The cap had been $363k before Congress “temporarily” raised it to $730k as part of the Stimulus package passed in February.

So far, so good. No behemoth bailouts above. But there are two more contentious provisions being pitched by Democrats that are likely to be introduced as amendments:

• Connecticut Senator Chris Dodd wants the federal government to insure $400 billion in new loans for homeowners. Scary.
• Illinois Senator Dick Durbin wants to give bankruptcy judges the power to alter the terms of certain mortgages. Also very scary. This would raise the cost of mortgages for everyone else as lenders boost interest rates to compensate for future risk that loans could be written down by judicial fiat…..