Friday, October 3, 2008

Buffett suggests improvement to TARP

From Fortune Magazine:
Warren Buffett suggested Thursday that the U.S. Treasury team with private investors to buy the distressed mortgage assets at the center of the controversial $700 billion Wall Street bailout, and said the price tag of the rescue plan may have to rise.

Buffett, the chairman and CEO of Berkshire Hathaway, called the problems facing world markets "unprecedented" and warned of a "disaster" if Congress does not move faster to shore up the economy.

"We had an economic Pearl Harbor hit," he said ... "For a couple of weeks we've been arguing about who's at fault [and] fooling around while things have gotten a lot worse." ...

"It will cost more to solve this problem today than it did two weeks ago," said Buffett...

But he described a plan he thought of Thursday morning on the way to the Summit that would allow Treasury and private investors to buy assets together. He said his proposal would kickstart demand for mortgage-backed securities, help find a market price for these troubled assets and make it more likely that taxpayers would be made whole or even come out ahead in the bailout.

Under Buffett's plan, Treasury would lend hedge funds, Wall Street firms or any other investors 80% of the price for distressed assets. Investors would benefit from borrowing at lower rates available to the Treasury. But the government would get first claim on the sale of those assets, which means it would get its loan back plus interest and possibly turn a profit. Only then would investors see a penny.

"Now you have someone with 20% skin in the game," explained Buffett. "Believe me, I won't be overpaying if I'm buying with that kind of leverage. And you have someone [the investors] to manage the assets to the extent they need to be managed."

Buffett also noted that the presence of the government in the transactions would raise the price of assets above the absolute firesale levels for which they could now be sold. That would benefit the banks trying to unload them. ...

He said the [financial] problem boils down to widely-held assumption during the housing boom that prices could only go up.
Under this scenario, the private investors would benefit by being able to borrow at ultra-low interest rates that normally only the government can get. They could also get higher potential returns by having higher leverage. Meanwhile, taxpayers are protected because the private investors would take a 100% loss before the government lost a penny. This gives the private investors a very strong incentive to protect taxpayers from a loss.

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