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  • Writer's pictureJeff Matthews

Hank Listens Up

Treasury Said to Invest $250 Billion in U.S. Banks By Robert Schmidt and Peter Cook

Oct. 14 (Bloomberg) — The U.S. will invest about $125 billion in nine of the nation’s biggest financial institutions, including Citigroup Inc. and Goldman Sachs Group Inc., as part of a $250 billion effort to shore up the banking system.

It seems like only a few weeks ago we here at NotMakingThisUp urged Hank Paulson—who at the time was pushing Congress for nearly a trillion dollars to buy bad assets from regretful bankers—to adopt, instead, the Warren Buffett plan of taking preferred equity stakes instead.

Hey, it was just a few weeks ago.

September 24, in fact.

In “The ‘Oracle’ Speaks: Listen Up, Hank,” we asked: “How is it that Warren Buffett can cut a better deal with the best-run financial company in America [Goldman Sachs] than the U.S. Treasury can ask from the worst-run financial companies in America?”

It looks like somebody else has been asking the same question, for in the Bloomberg story, we read the following:

The proposed cash injections in exchange for preferred shares are part of a $700 billion rescue approved by Congress and follow similar moves by European leaders to unfreeze credit markets by helping beleaguered banks….

The purchases represent a new approach for Treasury Secretary Henry Paulson, who first promoted a bailout targeted at illiquid mortgage-related assets.

Now, we claim no special smarts in having suggested Hank Paulson follow Warren Buffett’s example, as he is now doing.

John Paulson, the genius who made billions shorting the very bonds the Treasury was planning to buy, came out for much the same plan in a Wall Street Journal op-ed piece not long after.

And it seemed fairly obvious to us that a dollar spent buying bank equity would be worth seven or more dollars spent buying bank debt, given the leverage banks employ in the normal course of business.

Furthermore, if you were asked to bail out your errant neighbor who had misspent his fortune building a McMansion and now couldn’t pay his mortgage, would you really want to take over your errant neighbor’s mortgage, and become his creditor?

Of course not.

You’d rather get ownership in the house, not only to make sure the guy keeps up the place, but to get the upside when he finally sells it.

Like that errant neighbor, Wall Street did, after all, screw it up, only on a super-spectacular scale beyond all imagination.

And Wall Street did so after decades of lobbying government to deregulate the very industry Wall Street subsequently destroyed.

So now that all those Wall Street hotshots are running to the government as the buyer of last resort, it seems only fair that those hotshots give up the most valuable piece of the capital structure: ownership.

Is it any wonder that Hank Paulson—the former head of Goldman Sachs, and one of the hottest of those hotshots—didn’t want to do that in the first place?

Jeff Matthews I Am Not Making This Up

© 2008 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.

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