"Every day that Goldman does not call our preferred is money in the bank," Warren Buffett said last year. "Our preferred is paying $15 per second … so as we sit here… tick tick tick … its $15 in the bank. I don't want those ticks to go away."
Sadly for Buffett, they're going away. As has been expected, Goldman Sachs recently called Berkshire Hathaway's preferred stock investments.
This story begins in September 2008, when the entire financial system, including Goldman, neared collapse.
Buffett swarmed in, buying $5 billion worth of preferred stock in Goldman (and $3 billion in General Electric a few days later) on enviable terms.
The preferred stock yielded 10% and could be called (cancelled) by Goldman only at a 10% premium to par. Buffett also received warrants to buy 44 million Goldman shares at $115 a share.
After being given the green light by the Federal Reserve, Goldman is now repaying Berkshire's preferred stock, cancelling what has been expensive capital.
How'd Berkshire fare in this venture?
It's easy to get caught up in the big numbers ($15 per second!), but keep things in perspective. Berkshire has earned roughly $3.7 billion profit on a $5 billion investment over 2.5 years, which equals a return of about 25% per year.
This is a spectacular return, of course. But it, too, needs perspective.
Goldman announced Berkshire's investment on Sep. 23, 2008. The Dow, closing at 10,854 that day, has since returned roughly 6% per year including dividends.
Yet just a month later, on Oct. 23, the Dow was trading at 8,200. Anyone who invested in a simple index fund that day has earned about 19% per year since — still less than Berkshire's Goldman investment, but not remarkably so.
Move out to March 2009, and the Dow was around 6,600. Those who bought an index fund back then have since earned 37% per year — better than Berkshire's Goldman investment, even adjusted for the shorter time frame.
Shameless cherry picking
Or here's a non-hypothetical example. Buffett sold shares of ConocoPhillips in the fourth quarter of 2008 to, as he himself notes, fund Berkshire's investments in Goldman and GE.
There were likely some tax considerations in this move, but Conoco shares have since returned roughly 25% annually — the same return earned from the Goldman investment they helped fund.
This is shameless cherry-picking with the benefit of hindsight. Guilty as charged.
But it highlights an important point: There's an opportunity cost to every investment. Judged against alternative investments that could have been made during similar time frames, Berkshire's investment in Goldman looks good, but not great.
And those alternatives (a diverse group of blue chip stocks) could arguably be looked at as significantly safer than a single investment in an overleveraged investment bank, even if the latter came in the form of preferred stock.
Not worth the billions
Then there's the issue Buffett biographer Alice Schroeder brought up a year ago: Financial gain aside, was Buffett's alliance with Goldman — now a company most view as a symbol of moral hazard, regulatory abuse, and downright fraud — worth it?
"Buffett swapped his reputation at a cheap price," Schroeder writes. "It is painful to watch Buffett behaving like a hostage to Wall Street, damaging himself by defending investment banks and saying flattering things about Goldman in a way that contradicts any principled view of the securities business."
Buffett's partner Charlie Munger has shown shades of this contradiction. Last year, Munger was exceptionally critical of Lehman Brothers' behaviour, saying "the whole place was pathological about its extremeness." Yet on the same day he defended Goldman by saying:
"Goldman was in a world where Congress legalised all types of derivatives. It's an inherently dangerous world. Given that world, I see no reason to think Goldman misbehaved in some horrible fashion. Everyone was doing it, and it's only natural to increase your moneymaking activities when you can do so legally."
$15 per second matters
Yes, Lehman went bankrupt, and Goldman did not (although a little bailout influenced that outcome). Yet it's difficult to reconcile Munger's two views from a moral standpoint other than acknowledging that Goldman pays Berkshire $15 per second, and Lehman does not.
I don't mean this to be overly critical. In the end, Berkshire's Goldman investment worked as planned. That plan, though, may not have been as lucrative as some assume. As Schroeder notes: "The money wasn't enough. Goldman outsmarted Buffett in this deal."
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This article, written by Morgan Housel, was originally published on Fool.com. Bruce Jackson has updated it.
