NEW YORK -- The multi-billion dollar capital injection that Bank of America said it's getting from Warren Buffett's company is an extremely safe investment, experts said Thursday -- but not because Bank of America is a strong company.
Berkshire Hathaway's investment is safe, these finance experts said, because the government has the bank's back.
Although government regulators insist the era of bank bailouts is over, many who study the financial industry say the nation's biggest banks are still too big to fail, meaning they must be rescued by the government when they face potentially fatal trouble in order to prevent a broader collapse of the financial system. Bank of America, the country's largest bank by assets, is thought to rank high on this list -- a perception seemingly underscored by Buffett's willingness to put a significant sum into the company.
"This is the taxpayer giving Warren Buffett a great return," said Amar Bhide, a professor of international business at the Fletcher School of Law and Diplomacy at Tufts University. "He knows that Bank of America is too big to fail. If it is too big to fail, then why not?"
"It's not quite like buying Treasuries," Bhide continued, referring to U.S. government securities, "but it's not far from buying Treasuries at a really attractive rate of return."
Bank of America spokesman Jerry Dubrowski said any perception that the government is backing the bank isn't relevant, because the bank's fundamentals are strong.
"The Berkshire Hathaway investment is indicative of Mr. Buffett's confidence in the company and its long-term prospects," Dubrowski said. "We've made significant progress over the last two years to strengthen the balance sheet, dramatically build our reserves, and improve our liquidity to record levels."
Regulators who oversee financial institutions say "too big to fail" is no longer a concern, insisting that a new law gives them the ability to help a failing institution fail and prevent collateral damage.
Buffett's company struck a deal to invest $5 billion in Bank of America, in exchange for special shares of stock that annually throw off a 6 percent -- or $300 million -- dividend, according to a Thursday announcement from the bank. Berkshire is also getting contracts to buy 700 million common shares of stock at $7.14, a price comfortably below where the stock was trading after the deal was announced.
It's a sweet deal for Buffett, experts say, and an expensive one for the bank. But its immediate benefits were reflected in the stock price Thursday, which for weeks had been eroding as investors feared the bank wasn't as strong as it was insisting.
Buffett, the second-richest man in the United States and a much-admired investor, gave Bank of America his vote of confidence Thursday, a blessing that apparently inspired others to see the bank with new eyes.
The stock rocketed skyward after the opening bell Thursday, touching a high near 25 percent above Wednesday's close. It later came down to close up 9.44 percent. Not bad for a day when the Standard & Poor's 500 Index was down 1.56 percent.
The investment had many drawing comparisons to September 2008, when Buffett invested $5 billion in Goldman Sachs during the height of the financial crisis and secured a lucrative deal for his company. That was right before the government passed a bailout package known as the Troubled Asset Relief Program, rescuing a range of financial firms and confirming the wisdom of Buffett's bet.
Indeed, experts have argued that Buffett's company profited handsomely off the government's largess. Last fall, the investor penned an op-ed in the New York Times, thanking the federal government for propping up the financial system. "Uncle Sam, you delivered," Buffett wrote.
Now, at a time when investors fear for the health of the nation's banks, Buffett is again placing a large bet on a large financial institution.
"We might all be helping Warren Buffet if we come in to invest after him," said Anat Admati, a professor of finance and economics at the Stanford Graduate School of Business. "He knows precisely what he's doing, and he knows precisely what's going on."
Regulators take issue with that characterization of the financial system. They point to last summer's Dodd-Frank financial reform law, which provides a framework for allowing the government to unwind a failing financial institution without resorting to a full-fledged bailout.
"Bailouts are not permitted," said Michael Krimminger, general counsel of the Federal Deposit Insurance Corporation, in testimony before a House of Representatives panel in June.
But that authority is untested. In a crisis, it's hard to predict what might happen, Treasury Secretary Tim Geithner acknowledged last December. "You just don't know what's systemic and what's not until you know the nature of the shock," Geithner reportedly said.
Buffett himself has said "too big to fail" will always exist.
"You will always have institutions that are too big to fail, and sometimes they will fail," Buffett told the Financial Crisis Inquiry Commission in May 2010, in remarks that were made public this February.
"I do think that if you ran into a similar situation today the government would guarantee commercial paper again. They’d have to," Buffett said, according to a report from Bloomberg News at the time. "You have to believe the government, the federal government, will act and they will act promptly and decisively."
The crisis-era investment in Goldman Sachs, Buffett said, "was a bet essentially on the fact that the government would not really shirk its responsibility at a time like that."
A Berkshire Hathaway spokesperson did not respond to an emailed request for comment.
Bank of America has been plagued by fears that it could be on the hook for many billions in losses, as investors insist it buy back mortgage securities that went sour. The company reached a settlement agreement with investors this summer, pledging to pay $8.5 billion, but that deal froze when the New York attorney general cried foul.
The bank, along with four other institutions, is also in the process of negotiating a deal with all 50 state attorneys general and a host of federal agencies to resolve claims over its dubious mortgage and foreclosure practices during the housing boom. Those talks, too, have been stalled as a few key law enforcers push for a more thorough investigation of wrongdoing.
BofA stock, meanwhile, has gotten hammered. Fears that the economy might enter a new recession, and concerns about a sovereign debt crisis in Europe, haven't helped. This week, former stock analyst Henry Blodget opined that the bank might need to add as much as $200 billion in capital to protect against losses -- a huge number for a bank that's officially worth about $222 billion. BofA quickly dismissed the claim as misguided.
Yet as of Wednesday's close, Bank of America stock was worth about half of its value at the beginning of the year. The share price implied investors thought the bank was worth less than a third of what its official financial statement said.
"The company's fundamentals are very risky. That is clear," said Admati, the Stanford professor. "They have all kinds of things hanging that add uncertainty to their position. They're not in great shape."