JoeTaxpayer

Warren Buffet last week announced that he bought (through his company Berkshire Hathaway) $5 Billion worth of Goldman Sachs preferred stock which will yield 10%. Goldman can buy it back at any time at a 10% premium to its current value. Along with this deal Goldman threw in $5B in warrants to buy more shares at $115 any time over the next 5 years.

Let’s look at the windfall this deal is to Mr. Buffett and his shareholders:
A warrant is similar to an option, but usually for a much longer term. An option gives one the right, but not the obligation to buy a stock at a predetermined price (the ‘strike price’). So an option has unlimitted upside but a fixed downside. In this case, those warrants are included for free. But let’s look at what the $115 is currently worth.

You can see that just going out two years and a few months, a $115 strike would be worth about $46. Going out the full five years, the option value would be closer to $65. To be clear, the value of the warrants alone is $2.8 Billion. If Mr. Buffett wished to sell just these warrants, this is the amount he’d recover. Next, the shares of preferred stock he purchased for the $5 Billion will return 10% or $500 million per year. The next 5 years of cash flow have a present value of $1.996 Billion using a cost of money of 8% (and in these times, money costs less that that.) As we look at the financial crisis we are in, it’s clear that those who have money are going to get richer while the rest of us watch. The deal I described here is not available to you or me, not in smaller units of $5000, or even $50,000. When you or I buy shares of Goldman Sachs, we get 1% dividends and no warrants at all.

Joe

Regular readers will notice I offer a few links to charities I recommend for consideration. Today, I am adding another. The Second Step in Newton Massachusetts. Please read below for a description of this excellent charity (taken from their web site.)

“The Second Step, a private non-profit agency, seeks to break the cycle of domestic violence, one family at a time. We provide services to women and their children that enable them to remain free from abusive relationships and lead productive lives. Our mission is to provide transitional housing and support services to women and their children who have successfully taken the first step away from domestic violence. We provide a broad range of services to empower these women to heal, to maintain independence, and to achieve economic self-sufficiency.”

Joe

Unfortunately, the details are still not completely available yet, but I do have one thought. The market is currently in panic mode and a number of investment products seem to have no liquidity, in other words, no one knows how to price mortgage backed securities and so the prices are not really reflecting their true value.
I suspect that we will shortly discover that as true values are established, the taxpayer will actually come out ahead in this deal, not just from liquidity coming back into the market, but the government (and therefore the taxpayer) will see a profit in these takeovers.
Just my thoughts.
Joe

If you have not yet done so, please read part 1 & part 2 of this series first, then read on.

The classic Money Merge Account example suggests a $200,000 mortgage at 6% (normal payment = $1199.10), a monthly income of $5000, net, and $4000 monthly expenses including the mortgage payment. So there’s $1000 discretionary income each month.

In the simplest explanation, one takes $5000 from their HELOC at the very beginning of the cycle, and sends it to their mortgage as an additional principal prepayment. At that moment, the software congratulates you for having ‘canceled’ $23304.42 worth of interest on your mortgage. But during the course of the month, you borrow back $4000 to live on from your HELOC, and pay a higher interest rate (their examples use 8%) than the mortgage. Since you live on $4000 each month, you use the extra $1000 to pay down the HELOC, until the software tells you the right time to borrow more from the HELOC and send it to the mortgage. In one agent’s example, after a year of this process, one owes $185,486.95 between their mortgage and HELOC balances. But wait, when I run a simple spreadsheet, no HELOC, just paying the extra $1000 each month along with the mortgage payment, I show a year end balance of $185,208.41. I seem to be ahead by $278.54 even without taking the $3500 program fee into account. Hmmm.
Seems that MMA, with all its ‘sophisticated algorithms’ just creates more work for the user than the simple rule “send your extra money as a prepayment of principal.” Funny, one agent offers this as an example of how easy the MMA program is; “Your (sic) at the store and you see a great deal on steaks. Can should (sic) you buy them or will that mess up your budget. No big deal. Email or call the software from your mobile phone and it will text you back what you have in left in your budget for food and you can determine based upon what you have at home if you can afford it.”
Wait a second. I net $5000/mo. After paying all my normal bills and saving for retirement, I still have $1000/mo, and yet I’m emailing software to tell me whether I can afford to buy steaks on sale? Hello? What’s wrong with this picture?

Next week – do the example number make any sense?

Joe