Warren Buffett to the rescue?

A $5 billion stake in Goldman Sachs cheers investors. But his comments about "an economic Pearl Harbor" tell us what he really thinks

Published September 24, 2008 3:57PM (EDT)

To a Wall Street desperate for good tidings, Warren Buffett's $5 billion investment in Goldman-Sachs was interpreted as vote of confidence in the market. That's why, the insta-conventional wisdom says, stock prices reversed their downward trend late Tuesday afternoon.

But it's not so simple. If we know one thing about Buffett we know that he makes very good deals, and the Goldman Sachs investment is a very good deal, as Barry Ritholtz makes clear in his Big Picture analysis. Just for starters:

Goldman Sachs pays a fat dividend to Berkshire Hathaway of 10 percent on $5 Billion dollars -- that's $500 million per year. And, since this is a preferred, it gets paid out of net income in after tax dollars dollars. Ouch.

But even as news of the deal was filtering through the infosphere, Buffett said in an interview on CNBC that the current financial crisis should not be underestimated.

From Bloomberg:

Billionaire investor Warren Buffett, calling the market turmoil "an economic Pearl Harbor," said Treasury Secretary Henry Paulson's $700 billion proposal to prop up the U.S. financial system is "absolutely necessary."

"The market could not have taken another week" like last week, Buffett told CNBC today, a day after saying his Berkshire Hathaway Inc. will buy a $5 billion stake in Goldman Sachs Group Inc. "I think it was the last thing Hank Paulson wanted to do, but there's no Plan B for this."

We would do well to pay attention. Judging by the comments on my last post last night, "Wall Street on Trial," a substantial number of Salon readers subscribe to the "no bailout for Wall Street" camp. Let 'em all burn! Death and destruction to Wall Street!

I understand the passion, but it seems to be based on the theory that markets could collapse and scores of Wall Street financial institutions could go bankrupt, and the rest of us would proceed merrily along, unscathed. But that's just not how our economy works. If high finance implodes, markets collapse, and credit dries up, it's not just people like Warren Buffett who will see massive declines in their net worth. We will all suffer. Unemployment will surge. Anyone who has any savings that are linked to stocks will be hammered. Retirement funds will be pummeled.

Warren Buffett was eerily prescient when he warned in his 2002 letter to Berkshire Hathaway stockholders that the explosion of derivatives trading posed huge dangers:

The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts. In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.

He could not have been more correct then. My bet is his current pessimism is still on the money.

By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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