Goldman Sachs and Warren Buffett — Heros

Goldman Sachs chooses capitalism:

Warren E. Buffett, the country’s most famous investor and one of the world’s richest men, announced on Tuesday that he would invest $5 billion in Goldman Sachs, the embattled Wall Street titan, in a move that could bolster confidence in the financial markets.

It’s strange to think that an investment bank ([ahem]) a “bank holding company” and one of the world’s richest men will come off being scions of virtue in this mess.  But that’s exactly what they are.

The rationale for the mooted bailout is that the American financial system needs to be recapitalized.

There’s a lot that’s fishy about this.  Among them is the fact that there are many, many ways for this to happen without government intervention.  Goldman Sachs and Warren Buffett have come to one of them: allow private investors to buy new shares in companies desperate for capital.

Here’s the thing: either the Fed is going to pay a market price (or, its best, honest guess at market price) for assets that are currently booked above their market value.  Or — as seems more likely — the Fed is going to overpay for these assets in order to subsidize the American financial industry.

The truth is that, eventually, the most distressed firms will find ways to assign a fair market value to their mortgage-backed assets.  In that case, some firm will buy those assets — on the open market.  American capitalism survives intact.  The banks get punished by having to take the loss on bad investments.  And the financial system gets recapitalized.

Paulson’s approach essentially means that American tax payers are going to send a donation to banks, and then bear the costs when those assets are inevitably written down.  Meanwhile, the expanded debt means that there won’t be any money for the types of public investments that are going to get the American economy moving again.  Things like roads, bridges, and rail that not only create solid investment opportunities for the newly recapitalized banks, but also provide jobs for lower-middle income workers.

If the bailout goes through according to Paulson’s plan, we’ll likely end up in a liquidity trap anyway.  Sure, the banks will be recapitalized, but there will be precious little worthwhile investment to make as U.S. consumers tighten their belts and the U.S. government focuses all revenues on debt servicing.

Goldman’s and Buffett have it right — let the markets work for the purpose they were intended.  There’s going to be pain one way or another.  Let’s not pile on the hurt, and embeggar our country for generations to come.  Let’s hope the rest of the financial industry follows the lead of Goldman Sachs and Warren Buffett.

P.S. I also want to add that I think Goldman’s is betting that the federal government is going to be both inept and an unwelcome guest.  By using the markets to solve their problems Goldman Sachs ensures a much greater degree of regulatory independence in the future, which should enable them to be more competitive than other institutions that take the Fed’s handout.  Think welfare moms vs “up by the bootstraps” entrepreneurs.  It’s also interesting to note that Paulson is a former leader of Goldman Sachs, which makes you wonder “what do they know that everybody else doesn’t?”