COLUMN - Buffett has it both ways with Goldman Sachs

Mon Feb 28, 2011 7:42pm IST

Warren Buffett, CEO of Berkshire Hathaway, in Long Beach, California October 22, 2008.  REUTERS/Mario Anzuoni/Files

Warren Buffett, CEO of Berkshire Hathaway, in Long Beach, California October 22, 2008.

Credit: Reuters/Mario Anzuoni/Files

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-- The author is a Reuters Breakingviews columnist. The opinions expressed are his own --

By Rob Cox

NEW YORK (Reuters Breakingviews) - Warren Buffett once again used his annual letter to shareholders to rail against many of the Wall Street practices he has long despised, including hedge fund compensation, leverage and option-value pricing. What's odd this time around is to see the Berkshire Hathaway chairman's folksy criticisms set alongside a very public display of affection for one of the prime beneficiaries of these apparently wicked ways -- Goldman Sachs.

Now, it's easy to see why Goldman deserves a shout-out from the billionaire investor. He plugged $5 billion into the investment bank during the financial crisis. As part of that deal, he received preferred stock with juicy yields and warrants that allow him to purchase common shares for $50 a share less than they're currently trading at. Goldman, in short, has been very, very good to Berkshire shareholders.

So good, in fact, that the bank wants out. It has applied to the Federal Reserve to allow it to buy back the preference shares Buffett owns, and receives 10 percent annual payments on. But as Buffett notes, "Goldman Sachs has the right to call our preferred on 30 days notice, but has been held back by the Federal Reserve (bless it!)."

Buffett, however, does not bless the practices that characterize the industry Goldman leads. Once again, he takes the hedge fund world to task for "some terrible behavior." Goldman manages hedge funds and is one of the prime brokers to the industry. Buffett uses his letter to take on Black-Scholes, the conventional method used by Wall Street to value options. The model's eponymous co-inventor, Fischer Black, worked at Goldman Sachs. He chastises the use of leverage, one of the key ingredients of the private equity business that Goldman runs, characterizing it as one of the many forms of "financial adventurism" he and his partner Charles Munger try to avoid.

It's not necessarily wrong for Buffett to invest in an investment bank but dislike investment bankers. To his mind, Goldman may be an exception -- the one bank that's able to succeed without engaging in the more unsavory aspects of the business in which it operates. Whatever the case, it is not hard to see a contradiction.

CONTEXT NEWS

-- Warren Buffett, in his annual letter to Berkshire Hathaway shareholders released over the weekend, struck a positive tone on the prospects for the American economy, while once again railing against some of the practices that characterize the financial industry.

-- "Money will always flow toward opportunity, and there is an abundance of that in America," wrote Buffett. "The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential ... remains alive and effective."

-- Among other comments in the widely-followed letter, Buffett castigated some poor behavior in the hedge fund industry, expressed his concerns with the Black-Scholes options pricing model and said he was delighted the Federal Reserve has not allowed Goldman Sachs to redeem the preference shares it issued Berkshire in 2008.

(Editing by Jeffrey Goldfarb and David Evans)

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