Monday, April 19, 2010

Goldman Sachs let Warren Buffett learnt a bitter lesson

Warren Buffett, well-known as the "Oracle of Omaha", has been famous for value investing, and also declaring derivatives as the "weapons of economic mass destruction" and stated that he would never be involved in them.

He derailed from this belief, when Berkshire Hathaway in 2008, at the peak of the financial crisis, purchased $5 billion worth of Goldman Sachs' perpetual preferred stock with a 10% dividend and warrants on $5 billion worth of common stock at the price of $115.

Since then, Buffett has been talking good about Goldman Sachs and declaring his strong endorsement to its CEO Lloyd Blankfien. Last week, Ron Olson, one of Berkshire’s directors, once again defended Goldman  by saying that "Buffett invested out of belief in not just the strength of Goldman but its integrity."

To the great surprise of the whole world, it was just 3 days right after that "integrity" assurance from Berkshire, Goldman was accused by the US Securities and Exchange Commission (SEC) of defrauding its investors. A civil charge was filed on 16 April 2010.

Goldman is accused to have promoted and sold mortgage investments to its investors, without telling the buyers that the securities were crafted with input from its client, Paulson (a hedge fund capitalize on the housing bust), who was betting on them to fail.

The SEC said Paulson paid Goldman roughly $15 million in 2007 to devise an investment which tied to mortgage-related securities that the hedge fund viewed as likely to decline in value. Separately, Paulson took out a form of insurance that allowed it to make a huge profit when those securities' value plunged.

SEC stated that, "Goldman wrongly permitted a client (Paulson) that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective 3rd party."

Goldman's investors of that securities have lost about a billion dollar in less than a year thereafter, while Paulson reaped in its fabulous profit.

In fact, Goldman had been warned on this fraud case, in black-and-white by SEC, as early as in July 2009. The question is: did Buffett knew about that? If he didn't, then why? If he did, well, well, well....

The stock price of Goldman dropped heavily after this allegation, causing Buffett to gave out most of the profit he made earlier in his Goldman deal. However, the blow to Buffett is minimal in monetary wise. The bitter lesson to Buffett is the deteriotation to the reputation and respect which he built for decades, which had won him the title as the "Oracle of Omaha".

Now, all the eyes is staring on him, especially when the AGM of Berkshire Hathaway is just a moment away from now.

All investors make mistakes, including Buffett. But this mistake he made is really very costly. Let's wait what he'll say...


Anonymous said... Reply To This Comment

Buffett invests for the long-term; he's not a day trader. Just because the government and general public are currently scapegoating Goldman, causing the temporary drop in stock price, doesn't mean Buffett will lose out in the long run. I'm pretty sure that in 5, 10, 15, 20, 25 years' time, he will have made a profit on his investment in Goldman.

On a side note, Goldman is the cream of the crop when it comes to investment banks, and they're just being unfairly targeted now because the public wants someone to blame for the state of the economy and the SEC needs a PR win for letting Lehman go down/not doing anything about the financial meltdown. Goldman actually has better controls than most firms, and nothing they've done hasn't been done by Morgan Stanley, Citi, JPM, etc.

People really need to educate themselves properly before jumping to unfounded observations.

- Private Equity VP / former investment banker

Voyager8 said... Reply To This Comment


You didn't get the point.

It is not about the money, it is about the ethics.

This immorality scandal of Goldman Sachs is caused by collateralised debt obligations (CDO), a derivative product which is viewed as a game for investors to bet on, and creates no value to help companies raise capital to grow.

It is something that Buffett called the "weapons of economic mass destruction", and also known as the major cause for the previous financial meltdown in US.

Goldman had put together a tranche of low-quality mortgage loans with higher-quality and sold them as CDOs. Paulson had helped select the low-grade loans that were packaged into the CDOs, and Goldman allowed Paulson to place its bet against the CDOs turning bad.

If you were investor of the CDOs, what do you think?

And by investing in Goldman, and publicly talking good about this investment bank, including emphasizing on its so called "integrity", does this implies that Buffett supports this kind of business?

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