If Bank of America fails, taxpayers may be on the hook
Were you encouraged by Warren Buffett's $5-billion infusion of cash into Bank of America? Good, because you may end up paying Uncle Warren back.
Both Buffett and Bank of America CEO Brian Moynihan took great pains to sell Buffett's bailout as a strong vote of confidence in the troubled bank's leadership and sound financials.
Never mind that the bank's stock price is in the gutter because of a string of lousy acquisitions, most notably subprime mortgage lender Countrywide.
Or that it's been cutting jobs and throwing ballast overboard like crazy, most recently by selling half its stake in China Construction Bank Corp. to raise cash.
Forward, the odd couple vowed in Buzz Lightyear fashion. To future fortunes and beyond!
Well, at least one of them is headed in that direction.
As Huffington Post analyst William Alden points out, Buffett's all-in bet on BofA is about as risky as buying Treasury bonds, not because Bank of America is strong, but because the government has its back.
Alden maintains that despite recent financial reform, the nation's largest bank by assets is still "too big to fail," and Buffett knows it.
"This is the taxpayer giving Warren Buffett a great return," according to Amar Bhide, a professor of international business at the Fletcher School of Law and Diplomacy at Tufts University. "He knows that Bank of America is too big to fail. It's not quite like buying Treasuries, but it's not far from buying Treasuries with a really attractive rate of return."
Attractive is right.
The BofA deal gives the Oracle of Omaha 50,000 preferred shares with a 6% annual dividend -- an annual yield of $300 million -- plus warrants for 700 million shares at a rock-bottom guaranteed price of $7.14 with an unusually long 10-year exercise period.
"It's a sweet deal for Buffett, experts say, but an expensive one for the bank," Alden notes. Even after the announcement, which produced a modest, if short-lived uptick, Bank of America's stock closed at half what it was worth in January.
Buffett made his position clear in comments to the Financial Crisis Inquiry Commission back in May 2010: "You will always have institutions that are too big to fail, and sometimes they will fail," he said.
He made out like a bandit with a similar $5-billion private bailout of Goldman Sachs in 2008, and he can expect even better returns this time, given the lucrative terms that Bank of America was in no position to refuse.
Let's just hope the ship remains afloat long enough to pay Buffett back.
If it sinks, you and I may be on the hook to repay this generous loan from a rich uncle.