With $5B Goldman Play, Buffett Banks on Fed's Bailout

(MoneyWatch)  With his $5 billion investment in Goldman Sachs, super-investor Warren Buffett is betting the proposed $700 billion economic bailout package, now being hotly debated before Congress, will soon pass without any major changes or restrictions.

Once the proposed bailout legislation is law, the U.S. government becomes the ultimate buyer of bad debts, mostly subprime mortgages and other sick credits. Under the taxpayer-backed plan, the federal government evaluates and sells those faulty securities to new buyers. It will take years to accomplish this task, which hopefully makes some money along the way.

The bailout's more immediate intended impact is on the giant lenders and their investors. Free of toxic loans, lenders such as Goldman should, in theory, quickly re-emerge with cleaner and healthier balance sheets. They will be poised to start doing business again, provided they have an infusion of fresh money to stabilize and fund their operations.

That's where Buffett comes in. Without a federal bailout, the "Oracle of Omaha" would remain on the sidelines, shunnning financial sector stocks. Remember, it was only a few weeks ago that Buffett was so worried about the viability of the U.S. banking system that he ordered one his company's insurance subsidiaries to stop insuring bank deposits above the amount guaranteed by the federal government.
With a bailout, Buffett's risk in Goldman is drastically reduced and he stands to get a pretty good bang for his buck.
Ultimately, Buffett's Berkshire Hathaway could get a 10 percent stake in Goldman and will likely be asked to join the board by Goldman CEO Lloyd Blankfein. On top of that, Buffett will earn a nice 10 percent return on his investment, which is better than the going rate on most other investments.

Buffett fully expects a recapitalized Goldman will start making big money again even as the investment bank becomes more conservative and converts to a regulated bank holding company. A recapitalized Goldman will be competing against the emerging mega-banks Bank of America and JP Morgan Chase, which have made huge investment bank acquisitions at fire-sale prices during the Wall Street meltdown.

There are some risks associated with this investment. Most disturbing: Buffett could be wrong and the economic situation is worse than he, or anyone, believes. If so, Goldman's troubles have only started.

Meanwhile, Congress is questioning many aspects of the proposed bailout, including its lack of independent oversight, limits on CEO compensation and the risk to the economy.

Warren Buffett has already cast his vote. In backing Goldman, the billionaire investor is expecting U.S. taxpayers to pick up the tab for at least $700 billion in crummy loans.