The Berkshire Goldman Connection

Morningstar's Paul Larson puts Berkshire's Goldman investment into perspective.

The Berkshire Goldman Connection Jason Stipp: I’m Jason Stipp from Morningstar, when the SCC revealed that civil indictment against Goldman sects a couple of weeks ago naturally the Goldman stock dropped but interestingly so did Berkshire Hathaway. Now you might recall that Berkshire Hathaway made in investment in Goldman sects in the midst of the crisis so the question arises, what is the nature of this connection and what does it mean for investors. Here with me to dig in to that is Morningstar’s Paul Larson; he’s an equity strategist and editor of Morningstar stock investor. Paul Larson: Thanks for having me. Jason Stipp: So take us back to September 2008 first of all and please remind us what is the nature the investment that Berkshire took in the Goldman so we can understand this relationship? Paul Larson: Right, at the height of the crisis, Berkshire halfway invested five billion dollars into Goldman sects, into Goldman preferred stock and Berkshire received a 10% coupon on that particular investment. A very attractive investment for Berkshire Hathaway and then also as part of that deal almost as a throw in, Berkshire received the right to buy 43 and half million shares of Goldman at $115.00 a share and those were just barely in the water right when the deal was struck with the marker rebounding and Goldman rebounding. That particular investment has grown immensely for Berkshire. Jason Stipp: So sure you know there is obviously a direct connection here and there is you know a stake. Berkshire does have a stake—Goldman fell about 13% on that Friday when the indictment was announced and Berkshire was down 2%. Now do you think that that drop that the sales of Berkshire you know was it—did it make sense for the extent that the investment that Berkshire has in Goldman? Paul Larson: To summarize, I think the market overreacted here and continues to over react. It was painful for Berkshire Hathaway on the day that the SCC indictment was revealed because Berkshire which are basically stock options. Those fell in value in roughly one billion dollars but the market value of Berkshire stock fell by three times that amount. So there’s a little bit of disconnect regarding how much of a sell off should have occurred. Jason Stipp: So it's almost like the market saw Goldman in trouble, they remembered the investment that Berkshire made and all the attention was this one investment. Of course Berkshire has a much broader portfolio than just the investment in Goldman. Paul Larson: I think you hit the nail on the head, Berkshire is a very broad based company, and this is a company that has a balance sheet after the Burlington Northern Investment, roughly a 150 billion dollars worth of equity on it. So when you loose one billion of a 150, it's really not going to move the needle. Jason Stipp: Okay, so certainly it does seem like there was a market over reaction here in that case but there are some broader things that are happening with regulation and with financial reform that could potentially affect both Goldman and Berkshire. Tell us a little bit about what you’re seeing there and how there might be some indirect connections between these two companies. Paul Larson: Right, there are some indirect connections and that both companies are going to be affected by the financial regulatory reform that is currently being debated in Washington DC. What the final form of that regulatory structure is going to be is really anyone’s guess at this point and time but whatever is bad for Goldman sects is probably going to be a mild negative for Berkshire Hathaway. Particularly when it comes to derivatives, if there are any sort of increase requirements regarding how the collateral that stands behind these derivatives. That could significantly crimp Goldman style and mildly crimp Berkshire style. Jason Stipp: So potentially now that the market might over react again if there is some sort of regulation here and might present possibly and opportunity to pick up some Berkshire shares if they get depressed over this one issue that might affect it mildly? Paul Larson: Yes, that could be an interesting opportunity to buy Berkshire. Right now we don’t think that Berkshire is in the “buy territory” but it's certainly something to put in the radar. Jason Stipp: So I mean last question for you and we’ve gotten some questions from readers about this and Buffet has famously said that derivatives are weapons of mass destruction and yet now he’s back on the news. You know with this derivatives issues and it almost seems like its coming back to bite him a little bit. He actually holds these things that he was talking against a while back. What’s your take on Berkshire derivative positions and how do you sort of think about them and think about what he said and kind of justifies those? Paul Larson: Well one key difference here is that in most derivatives, you have some counterparty risk and the way that Berkshire particular derivatives were structured, Berkshire got the cash up front and so there’s really no counter party risk. All that risk is in Berkshire counterparty and I would also say that this is not a meaningful derivatives exposure that’s going to tip over the entire apple car if they are to go array and Berkshire has the financial strength to pay this off should it come to that. It’s worth noting that right now Berkshire is in the block on these particular derivatives on the equity index that they made the bet on and I would expect that they would continue to profit from their derivatives activity. Jason Stipp: Paul thanks for the insights and for the context. Paul Larson: Thanks for having me. Jason Stipp: For Morningstar I’m Jason Stipp, thanks for watching.