Warren Buffett: Baptist and Bootlegger
In 19th-century America, there was a concerted effort to ban alcohol sales on Sunday. “Blue laws,” intended to protect the sanctity and sobriety of the Sabbath, were pushed by what seemed like an odd alliance: Baptists and bootleggers. Baptists backed the ban publicly on moral and religious grounds, while the bootleggers lobbied for the ban privately to boost their own bottom lines. Blocking legal alcohol purchases for even one day each week meant more opportunities for their illegal sales. Bans were enacted state by state, and many blue laws still exist (in Arkansas, Indiana, Minnesota, and Mississippi, for example), although restrictions have been steadily disappearing in recent years. Economist Bruce Yandle immortalized the phrase “Bootleggers and Baptists” in a 1983 Regulation magazine article of the same name, making the point that ostensibly opposing sides will happily collude when it serves their mutual interests.
The old paradox continues in modern-day Washington. Politicians enrich their friends and allies—and sometimes themselves—by coming off as earnest “Baptists” for a worthy cause. Lobbyists for big corporate interests, by contrast, are widely considered bootleggers, no matter how nobly they cloak their arguments. This arrangement has created an opening for a third way: What if a capitalist could somehow manage to sound like a Baptist?
Consider Warren Buffett. Often seen as a grandfatherly figure above the rough-and-tumble of politics, Buffett appears to be immune to the folly and excess of finance as well. He lives in Omaha, Nebraska, in a house he purchased in 1958 for $31,000. He made a fortune for himself and his investors at the business conglomerate Berkshire Hathaway through the humble-sounding approach of value-based investing. He uses folksy expressions: “You don’t know who’s swimming naked,” he said during the height of the financial crisis, “until the tide goes out.” He frequently takes to the nation’s op-ed pages with populist-sounding arguments, such as his August 2010 plea in The New York Times for the government to stop “coddling” the “super-rich” and start raising their taxes.
Buffett the Bootlegger
But this image does not always reflect reality. Warren Buffett is very much a political entrepreneur; his best investments are often in political relationships. In recent years, Buffett has used taxpayer money as a vehicle to even greater profit and wealth. Indeed, the success of some of his biggest bets and the profitability of some of his largest investments rely on government largesse and “coddling” with taxpayer money.
During the financial crisis in the fall of 2008, Buffett became an important symbol on television. He filled the role of fiscal adult, a responsible father figure in the midst of irresponsible Wall Street speculators. While pushing for calm and advocating specific market interventions in both public and private, however, he was also investing (sometimes quietly) so he could profit once his policy advice was implemented. This put Buffett in the position of being both Baptist and bootlegger, praised for his moral character while shaking his finger all the way to the bank.
In the summer of 2008, when several investment houses and the government-sponsored mortgage companies Fannie Mae and Freddie Mac teetered on the brink of financial collapse, Buffett was “uncharacteristically quiet,” as the London Guardian observed. It was only on September 23 that he became a highly visible player in the drama, investing $5 billion in Goldman Sachs, which was overleveraged and short on cash. Buffett’s play gave the investment bank a much-needed cash infusion, making a heck of a deal for himself in return: Berkshire Hathaway received preferred stock with a 10 percent dividend yield and an attractive option to buy another $5 billion in stock at $115 a share.
Wall Street was on fire, and Buffett was running toward the flames. But he was doing so with the expectation that the fire department (that is, the federal government) was right behind him with buckets of bailout money. As he admitted on CNBC at the time, “If I didn’t think the government was going to act, I wouldn’t be doing anything this week.”
Buffett needed the bailout. In addition to Goldman Sachs, which was not as badly leveraged as some of its competitors, Buffett was heavily invested in several other banks, such as Wells Fargo and U.S. Bancorp, that were also at risk and in need of federal cash.
So it’s no surprise that Buffett began campaigning for the $700 billion Trouble Asset Relief Program (TARP) that was being hammered out in Washington. The first vote on the bill failed in the House of Representatives on September 29. But Buffett was in a unique position to help reverse its fate.
During the 2008 presidential campaign Buffett was mentioned as a candidate for Treasury secretary by both John McCain and Barack Obama. But it was clear where his loyalties lay: He had been a financial supporter of Barack Obama going back to 2004, when Obama ran for the U.S. Senate. Each had been impressed when they met, and Buffett said at a 2007 fundraiser in Nebraska that the two “had a lot of time to talk.” During his 2008 presidential campaign, Obama made it clear that while he received plenty of advice on the campaign trail, “Warren Buffett is one of those people that I listen to.” Obama added that the Oracle of Omaha was one of his “economic advisers.”
Several senators and congressmen were shareholders in Berkshire Hathaway and therefore in a position to earn big returns by passing the bailout bill. Sen. Ben Nelson (D-Neb.), for example, held between $1 million and $6 million in Berkshire stock, by far the largest asset in his portfolio. Initially resistant to the bailout bill, Nelson ended up voting in favor of it. Buffett’s support was hardly the deciding factor in passing the bill. But his Baptist-bootlegger position was strong in both directions: Many people heeded his advice, then he (and they) made a lot of money after the bailout.
Throughout the financial crisis and the debate over the stimulus in early 2009, several members of Congress were buying and trading Berkshire stock. Sen. Dick Durbin (D-Ill.) bought Berkshire shares four times over a three-week period in September and October 2008, up to $130,000 worth. He bought shares during the debate over the bailout, during the vote, and after the vote. Sen. Orrin Hatch (R-Utah) bought the stock, as did Sen. Claire McCaskill (D-Mo.), who bought up to $500,000 worth just days after the bailout bill was signed. Some legislators also followed Buffett’s example by buying shares in Goldman Sachs after the bailout. Among them were Rep. John Boehner (R-Ohio), Sen. Jeff Bingaman (D-N.M.), and Rep. Vern Buchanan (R-Fla.).
Early in the financial crisis, Obama, then a senator and his party’s presidential nominee, had been cautious and lukewarm about a possible bailout. But in the days following Buffett’s multibillion-dollar play for Goldman Sachs, and with fears of economic collapse mounting, Obama became a powerful champion of the government rescue. As the top Democrat in the country, he had an important vote. The New York Times reported that Obama “intensified” his efforts to “rally support for the $700 billion financial bailout package” after September 28, 2008. The plan was necessary, said Obama, “to safeguard the economy.”
Publicly, Buffett struck a posture of cheering on the bailout from the sidelines. “I’m not brave enough to try to influence the Congress,” he told The New York Times in a September 24 article. But Buffett’s actions directly contradicted his words. Days later, he participated in a conference call with House Speaker Nancy Pelosi (D-Calif.) and other House Democrats during which he pushed them to pass the bill, warning that otherwise the country faces “the biggest financial meltdown in American history.”
The stakes were high for Buffett as well. If the bailout went through, it would be a windfall for Goldman. If it failed, it would be disastrous for Berkshire Hathaway.
The first vote failed, as Congress faced enormous heat from voters angry about the prospect of aiding Wall Street. On the eve of the second TARP vote in the House, Buffett moved toward the fire again, buying a $3 billion stake in corporate giant General Electric (GE). As with Goldman, he was able to negotiate advantageous terms, receiving a 10 percent dividend on his shares. He also purchased the option to buy $3 billion in stock at discounted terms. GE was in even worse financial shape than Goldman, thanks to its financial arm, GE Capital. Eventually it would receive $140 billion in taxpayer capital to stay afloat.
Buffett, a genius at public relations, said he had “confidence in Congress to do the right thing.” He appeared to be the private-sector savior of Goldman Sachs and GE, while giving members of Congress much-needed cover to bail out what had recently been among Wall Street’s most favored firms.
Crony Capitalism Pays
With the passage of the Emergency Economic Stabilization Act, the Treasury Department was authorized to loan financial institutions a total of $700 billion, which gave it unprecedented authority to pick winners and losers. Access to TARP money was not guaranteed, and the terms of the loans were unclear. The process was opaque. As American Prospect Editor Robert Kuttner put it, the TARP proceedings were conducted “largely behind closed doors, and the design is by, for and in the interest of large banks, hedge funds, and private equity companies. Because there are no explicit criteria, it’s very hard to know” if anyone got special treatment. The entire process, he said, “reeks of favoritism and special treatment.”
Having the correct political connections was critical. A National Bureau of Economic Research study by four researchers at the Massachusetts Institute of Technology, documented the power of such connections. Economist Daron Acemoglu and his colleagues found that when Timothy Geithner, a man who had spent his career shuttling back and forth between Wall Street and Washington, was announced as President Obama’s nominee for treasury secretary, it “produced a cumulative abnormal return for Geithner-connected financial firms of around 15 percent from day 0.” The stock market reflects the thinking of all investors, and they clearly believed Geithner would be able to reward his friends directly or indirectly.
Conversely, when there was word that Geithner’s nomination might be derailed by tax issues, those same firms were hit hard with “abnormal negative returns.” Acemoglu et al. systematically examined companies that had corporate ties to Geithner, had executives who served with him on other boards, or had other direct relationships. They found that “the quantitative effect is comparable to standard findings” in Third World countries with weak institutions and higher levels of corruption. In other words, markets react to government actions in the U.S. the same way they do in a corrupt developing country. Crony capitalism pays, and the market knows it.
Buffett, of course, was not the only one with connections in Washington. Goldman Sachs had a direct line to Bush administration Treasury Secretary Henry Paulson, its former managing partner, as well as incoming officials in the Obama administration. But Buffett was far better liked by the American public than were the executives at Goldman Sachs. He was therefore a much more effective advocate for bailout funds than Paulson could ever be.
An April 2011 working paper by researchers at the University of Michigan School of Business found that “firms with political connections” were much more likely to get TARP funds than firms that were not well connected. The study looked at how much money companies contributed to election campaigns through PAC contributions and donations by executives as well as how much companies spent on lobbyists. Finance professors Ran Duchin and Denis Sosyura found that politically connected firms, despite the infusion of federal funds, were outperformed by unconnected firms. In other words, poorly run but well-connected companies got the loot.
The fact that politically connected banks got good deals from the Treasury was not lost on the banking industry. Robert Wilmers, the chairman and CEO of M&T Bank, told shareholders in April 2009, “The pattern is clear: The bailout money and the perks are concentrated among the big banks, the ones who pay the lobbyists and make the campaign contributions, while the healthy banks pay the freight.”
Buffett needed the TARP bailout more than most. In all, Berkshire Hathaway firms received $95 billion in TARP money. Berkshire held stock in Wells Fargo, Bank of America, American Express, and Goldman Sachs, which received not only TARP money but also Federal Deposit Insurance Corporation (FDIC) backing for their debt, worth a total of $130 billion. All told, TARP-assisted companies constituted a whopping 30 percent of Buffett’s publicly disclosed stock portfolio. The folksy outsider with his home-spun investment wisdom, the Houston Chronicle concluded in an April 2009 investigative piece, was “one of the top beneficiaries of the banking bailout.”
Buffett received better terms for his Goldman investment than the government got for its bailout. His dividend was set at 10 percent, while the government’s was 5 percent. Had the bailout not gone through, and had Goldman not been given such generous terms under TARP, things would have been very different for Buffett. As it stood, the arrangement with Goldman Sachs earned Berkshire about $500 million a year in dividends. “We love the investment!” he exclaimed to Berkshire investors. The General Electric deal also was profitable. As Reuters business columnist Rolfe Winkler noted on his blog in August 2009: “Were it not for government bailouts, for which Buffett lobbied hard, many of his company’s stock holdings would have been wiped out.”
By April 2009, Goldman share prices had more than doubled. By July 2009, Buffett had already received a return of $2.5 billion from his investment.
Later, astonishingly, Buffett would publicly complain about the bailouts in his 2008 letter to Berkshire investors, claiming that government subsidies put Berkshire at a disadvantage. As he put it, funders “who are using imaginative methods (or lobbying skills) to come under the government’s umbrella have money costs that are minimal,” whereas “highly-rated companies, such as Berkshire, are experiencing borrowing costs that…are at record levels.” Berkshire, of course, is simply a holding company representing a long list of investment assets—including investments in eight banks that were helped by the FDIC’s Temporary Liquidity Guarantee Program. As Winkler put it, “It takes chutzpah to lobby for bailouts, make trades seeking to profit from them, and then complain that those doing so put you at a disadvantage.”
Unseemly but Legal
There are two main questions to ask about Buffett’s behavior. First, why do so many people continue to heed his policy advice without considering his enormous self-interest? Second, and more important, how did our politics get so warped by deep-pocketed, heavily invested advisers?
After the bailout bill passed, Warren Buffett sat down and wrote Treasury Secretary Paulson a four-page letter proposing a larger solution to the financial crisis: a quasi-private fund backed by the U.S. government that would buy bad loans and other rapidly sinking investments. He proposed that for every $10 billion put up by the private sector, the federal government would kick in $40 billion. As Paulson put it in his memoir, “I knew, of course, that as an investor in financial institutions, including Wells Fargo and Goldman Sachs, Warren had a vested interest in the idea.”
The bootlegger’s interest does not necessarily mean the Baptist’s ideas are wrong. The Treasury Department considered Buffett’s proposal, but with Paulson leaving at the end of President George W. Bush’s term, it would fall to the incoming secretary, Tim Geithner, to act on it. Geithner tweaked the plan and announced the Public-Private Investment Program in March 2009. It was largely seen as a boon to banks, especially large banks with a lot of bad debt.
What did Buffett do in the six months between writing the letter and watching the adapted policy get approved? He bought more bank stock. According to Berkshire’s quarterly reports, Buffett’s firm bought 12.4 million shares of Wells Fargo during this period and another 1.5 million shares in U.S. Bancorp. When Geithner announced the Public-Private Investment Program, bank stocks rallied and Buffett’s holdings did very well. We don’t know the exact price that Buffett paid for these millions of shares because he is not legally required to list the dates he bought them. But we do know those bank stocks all jumped after Geithner unveiled his program. Wells Fargo, which was trading around $20 per share early in 2009, jumped to $30 a share in the weeks following Geithner’s announcement. U.S. Bancorp did even better: It had hit a low of $8 a share in February 2009 but vaulted to more than $20 a share by May. And of course Buffett already owned tens of millions of shares in a host of financial companies, such as American Express and M&T Bank, which also benefited.
Buffett did very well with Goldman Sachs and GE too after they received their bailout money. His net gain from General Electric as of April 2011 was $1.2 billion. His profits from the Goldman deal by then had exceeded the gains of July 2009, reaching as high as $3.7 billion. He had bet on his ability to help secure the bailout, and the bet paid off.
In the fall of 2010, Buffet wrote a “Thank You, Uncle Sam” op-ed piece in The New York Times, praising the role that the government played in stabilizing markets throughout the crisis. There was no disclaimer or disclosure of how much he personally gained from TARP or the Public-Private Investment Program. He simply endorsed both as good public policy. At the bottom of the article he was identified this way: “Warren E. Buffett is the chief executive of Berkshire Hathaway, a diversified holding company.”
With tongue in cheek, journalist Ira Stoll, the former managing editor of the New York Sun (and current columnist for reason.com), suggested the bio might have been more accurate with a bit of rewriting: “Warren Buffett, the largest crony capitalist in the world, shareholder of GE, Goldman Sachs, Wells Fargo, U.S. Bancorp, M&T Bank, and American Express, as well as competitor of private equity and hedge fund firms that have been threatened with new taxes and regulations, and behind the scenes, insider adviser to most of the government officials mentioned above.”
Again, to be clear, even though Buffett was the one who proposed the public-private partnership, there is absolutely nothing illegal about lobbying for a policy while investing in the companies that stand to gain most if that policy is adopted. But consider this: Had Buffett instead pushed a private investment house to make an acquisition that would benefit certain stocks while quietly buying shares in those same stocks, he would have been vulnerable to charges of insider trading.
Indeed, this is what his lieutenant David Sokol was accused of doing in 2010, landing him in legal hot water. Sokol, who resigned amidst insider trading accusations, apparently bought shares in Lubrizol, a chemical company, and then encouraged his employer, Berkshire Hathaway, to buy a large stake in the company, thereby driving up the price of the stock. All Buffett did differently was use the federal government instead of a private company to boost the fortunes of certain stocks. This is why crony capitalism is so perennially attractive to financiers: It’s legal, and it’s often more remunerative than the illegal private-sector version might be. Because government officials are dealing with other people’s money, they are less likely than a private firm to drive a hard bargain.
Buffett has long believed that corporate-government partnerships provide excellent investment opportunities. While he’s famous for owning Dairy Queen and other all-American private companies, two of his largest holdings are in railroads and regulated utilities. He regularly lobbies on their behalf and counts on significant public money to make them more profitable.
After the 2008 financial crisis appeared to be easing, Buffett turned his attention to championing the Obama administration’s stimulus program. When he went on television to hawk the stimulus, he was never asked what he might personally be getting out of the deal. A candid answer would have taken up many valuable minutes of airtime.
Railroad Job
In late 2009, Buffett made his largest investment ever when he decided to buy Burlington Northern Santa Fe Railway (BNSF). It was not just an endorsement of the railroad industry’s financials; it was also a huge bet on the budget priorities of his friend Barack Obama. As The Wall Street Journal reported, “Berkshire Hathaway Inc.’s planned purchase of Burlington Northern Santa Fe Corp. represents a bet that upcoming Washington policies to improve infrastructure and combat climate change will be a boon to the freight-railroad industry. President Barack Obama has said railroad investment will be a cornerstone of his transportation policies, given the environmental benefits and improved mobility that come with taking cars and trucks off roads.”
Others in the railroad industry saw Buffett’s involvement as very helpful, precisely because he was so politically connected. “It’s a positive for the rail industry because of Buffett’s influence in Washington,” Henry Lampe, president of the short-haul railroad Chicago South Shore & South Bend, told the Journal.
Buffett bought BNSF just as the Obama administration was beginning a series of initiatives to rapidly expand the government’s spending on railroads. After Buffett took over the railroad company, he dramatically increased spending on lobbyists. Berkshire spent $1.2 million on lobbyists in 2008, but by 2009 its budget had jumped to $9.8 million, where it more or less remained. Pouring money into lobbying is perhaps the best investment that Buffett could make.
Obama’s plans to invest heavily in railroads, including a commitment to high-speed rail, put BNSF in a position to benefit handsomely. BNSF already has talked to Seattle officials about leasing or selling its rail lines for an intercity project, and that’s just a start. A map of BNSF lines around the country overlaps nicely with the government’s proposed high-speed rail lines, from Seattle to Florida, California to the Northeast. Buffett is geographically and strategically positioned to profit from those government-funded rail systems, should they be built.
The 2009 stimulus package includes $48 billion (of the total $787 billion) for infrastructure improvement, a chunk of which is headed for railroads. How much will BNSF benefit? It’s hard to calculate. Type “BNSF” on the Recovery.gov website, which tracks grants, subsidized loans, and contracts signed under the stimulus, and you find 1,800 entries, including everything from a $36 million grant from the Department of Homeland Security to money from the Environmental Protection Agency.
Buffett also owns MidAmerican Energy Holdings, which received $93.4 million in stimulus money. General Electric, in which he owns a $5 billion stake, was one of the largest recipients of stimulus money in the country.
Buffett famously puts his folksy investment ideas in an annual letter to Berkshire investors. He rarely mentions the bootlegger stuff involving lobbyists, government funds, bailouts, and stimulus grants, preferring the Baptist language of social good. “We see a ‘social compact’ existing between the public and our railroad business, just as it is the case with our utilities,” he said in his 2010 letter to shareholders. “If either side shirks its obligations, both sides will inevitably suffer. Therefore, both parties to the compact should—and we believe will—understand the benefit of behaving in a way that encourages good behavior by the other. It is inconceivable that our country will realize anything close to its full economic potential without it possessing first-class electricity and railroad systems.” He added that both businesses “require wise regulators who will provide certainty about allowable returns so that we can confidently make the huge investments required to maintain, replace, and expand the plant.”
The term social compact sounds benign. But when did American voters agree to turn one of the richest men in America into one of the biggest recipients of taxpayer subsidies?
In August 2011, Buffett vacationed with President Obama on Martha’s Vineyard, and they discussed the economy. Shortly after that, he agreed to host an Obama re-election fundraiser in New York City where contributors could buy $35,800 VIP tickets to meet Buffett and talk about the economy.
As fellow investor Steven Rattner pointed out in his 2010 book Overhaul: An Insider’s Account of the Obama Administration’s Emergency Rescue of the Auto Industry, “Warren Buffett has shown that superb investing need not entail the months of due diligence and deliberation that private equity firms typically apply to a deal. Buffett has been known to make successful multibillion-dollar bets on the basis of a few meetings or phone calls.” That is particularly true if he calls Washington.
Warren Buffett is a financial genius. But even better for his portfolio, though worse for the rest of us, he is a political genius.
SOURCE: Peter Schweizer from the March 2012 issue - Reason Magazine
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