Expect a new order after 'blood flows in the Street'

Bangkok Post  |  Sep 29, 2008

By Sin-ming Shaw

When Warren Buffett speaks, the world listens. When he acts, the world better pay attention.

Mr Buffett has bought about 10% of Goldman Sachs. The market considered the purchase a sign of confidence in the company. Not everything Mr Buffett has ever bought worked out as planned, though most did.

In 1998 he bought General Re, an insurance company that turned out to be a can of worms giving him not only a close look at a mix bag of derivatives General Re executives had foolishly bought, but also got him into many legal tangles with the government because of what General Re had done.

Mr Buffett did not call derivatives "financial weapons of mass destruction" without good reason.

While we may feel a little reassured that the Man with the Golden Touch has put $5 billion into Goldman Sachs, we should wonder why Goldman Sachs, supposedly the strongest, the best, bluest chip of all the investment banks needed to sell and at the most favourable terms to the buyer no less.

The terms are extraordinary. According to a September 24 New York Times report: "Berkshire Hathaway [Mr Buffett's investment vehicle] will receive perpetual preferred shares in Goldman, which will pay a 10 percent annual dividend, or $500 million a year. Those dividends take precedence over other payments to common shareholders. Goldman has the right to buy back the shares at any time for a premium of 10 percent.

In addition, Berkshire Hathaway will receive warrants to buy $5 billion in common stock at a strike price of $115 a share, which can be used at any time in a five-year period. Those warrants are already in the money: Goldman shares closed Tuesday at $125.05, up $4.27, and rose to $134.75 in after-hours trading after Mr Buffett's investment was announced."

You don't need much financial expertise to realise it was a distress sale. Goldman needed capital badly to have had to agree to such terms. This also means the Wall Street meltdown is at present only on a holding pattern.

The urgency with which Hank Paulson, US Treasury Secretary and Fed Chairman Bernanke want the US Congress to hand them a blank check of $700 billion now takes on new meaning.

Underlying the urgency must be their realisation that without that check available right away, the alternative might be a catastrophe the shape of which one dare not imagine.

There is a risk that an order of an unpredictable kind will be imposed on policy makers around the world by a panicked world.

That new order we can only imagine is likely to have the following elements. The financial markets will have a lot further to fall. Dow at 8000 or lower is not out of the question, with the Hang Seng closer to 14000 than to 24000 within the next 12 months. There will be rising global unemployment, even in China where growth will be cut short by high inflation and low global demand. Gold could reach $1300 an ounce with oil approaching $200 a barrel before an inevitable collapse destroying more personal wealth and corporate capital, causing further global unemployment.

Right now the rest of the world is still sitting on their collective hands, either like the French sniggering at the collapse of US-style financial capitalism or like China keeping its views to itself.

The incident involving Bank of East Asia is only a tiny pre-appetiser taster of what could hit the major financial centres if the world does not rise up to the occasion.

Goldman and Morgan Stanley have already ceased to exist as investment banks, so it is no longer meaningful to use Wall Street as a symbol of American capitalism at its most creative or at its most destructive - like a neutron bomb that instead destroys assets without causing actual deaths.

Every major investment bank in the US has disappeared. Everyone is now a conglomerate bank such as HSBC with an investment banking department under the control of the Federal Reserve Board.

In the new order governments in Beijing, Moscow, Tokyo, a few multibillionaires such as Mr Buffett, oil-rich Arab sheiks, perhaps a couple of Hong Kong's super rich, will own Wall Street - after "blood in the Street".

That's not all. The radical Republican Party faction that has taken over the US political agenda since Richard Nixon's presidency replacing the traditional moderate, middle-of-the-road, fiscal conservatives represented by such leaders as Dwight Eisenhower and Nelson Rockefeller will finally be discredited as a bunch of crazy nuts on par with utopian but ultimately amoral, cynical Marxism that impoverished Eastern Europe and China for over half a century.

The deliberate and systematic dismantling by the Bush crowd of oversight expertise in the US government is criminal, if not by law, certainly by ethical standards.

What is clear that for a market to function properly as in soccer is this: mayhem will result on the field without a competent team of referees. And that means competent regulators and laws to ensure the proper working of the market. They are there not to suffocate the markets but to make sure they work well and stay open, fair and efficient.

For too long the new Republican Party has been replacing competent public servants with business lobbyists who in that dishonestly twisted logic would represent the best interests of the market.

Nonsense. They represented narrow financial interests without any regards to the greater good of the country.

Meanwhile the French will be laughing all the way to their chatty salons celebrating the demise of the "Anglo Saxon" model of economics. They think the Statist model is the way of the future. One day a swing away from Statism towards a free market will surely occur. As greed once again takes over, the world will begin once again a bull market.

Until then, prepare for more surprises. The only certainty right now is uncertainty.

Sin-ming Shaw is a former fund manager and visiting scholar at Princeton.

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