Morgan Stanley (MS) And Goldman Sachs (GS) Make Case For Private Bailout Of Industry

The Treasury is making the case that the financial industry needs $700 billion to take toxic assets off bank balance sheets. This should free up liquidity and ease credit problems. Treasury Secretary Henry Paulson is even willing to pay prices close to the future value of where the bonds will trade when they mature. If he is wrong, taxpayers may be a bit poorer for his miscalculation.

While all of the fisticuffs go on in Congress as the parties fight over how legislation can solve the problem, Goldman Sachs (GS) raised $10 billion in a fairly short time. Morgan Stanley (MS) got $8.4 billion from Mitsubishi UFJ. The Japanese firm will probably end up with 20% of Morgan. While the capital was raised to improve the balance sheets of the investment firms which are changing into banks, it might have been applied, at least in part, to covering losses from derivatives.

The most troubled large financial firm in the US is probably Washington Mutual (WM). But, several private equity firms are looking at buying it or putting in capital in exchange for a large piece of the mortgage and banking operation. According to The Wall Street Journal, "Among the private-equity firms that are considering a possible transaction are Carlyle Group LLC and Blackstone Group LP." The people at these companies are intelligent and most have Ivy League educations. Their interest in WaMu must be based on some consideration that the institution still has substantial value.

There is still capital in the market willing to invest in financial companies. As the management at Goldman learned, the price of that capital is high. The operation will pay Warren Buffett a 10% yield on his preferred shares. The usury laws in most states would not have allowed him that kind of coupon.

Treasury may have its way. It may get its capital and exchange it for toilet paper from the banks. It may pay close to top dollar for those assets to save the financial firms from further losses and write-downs. The whole system may even work.

If the Treasury program is turned down or perverted in it purpose by Congressional add-ons, there is still some evidence that large pools of capital have an interest in buying into banks. The money may be exorbitantly expensive, but it is there.

Investments in the US banking system may not be worth much now, but there are funds that are willing to gamble that there will be tremendous value in those assets five years from now. As Buffett showed, the rich can afford to wait.

Douglas A. McIntyre