Warren Buffett has provided an interesting proposal for the use of the Treasury moneys just recently passed by the US Congress and Senate. According to Buffett, allow people who do have funds available to invest to put up a 20% equity stake in the purchasing distressed assets with the Treasury providing the other 80%. In this case you allow for three things:
1) assets purchased will be subject to market factors for the ‘best deal’ because private investors will have an equity stake in the asset. Hence reducing the risk of distressed assets being sold at a premium simply for the sake of the fact that in Government’s haste to purchase assets they may not necessarily value them properly;
2) It inherently increases the bailout funds from $700B to $840B at the stroke of a pen without putting inflationary pressure on the monetary system, and;
3) The investor becomes a partner in managing the asset to the extent that it needs to be managed.
This last point I feel is probably the crucial piece that has been overlooked in all of this. It was something I brought up last week and is interesting, I feel, that Buffett is also making note of this. Real Estate assets need to be managed and require ongoing operational capital if there is going to be any hope of turning a profit once real estate prices start to rebound. By using the treasury funds to essentially provide interest free / low interest loans to investors, you have the capability to induce the investor to provide the needed capital to maintain the properties rather than having to go back to Congress to admit that this $700B bailout package screwed up on the whole ‘on-going’ costs thing.
Consider that a $300,000 house will typically have approximately $5-6,000 in ongoing operational costs to manage and maintain (not including work that is necessary for basic repair and maintenance such as lawn care), if you position the investor to take on those ongoing costs rather than the government, it essentially provides for a reasonable method of limiting the Government’s exposure to having to inject further capital for assets that they are ill-equipped to manage effectively.
As a plan – it is more than reasonable. However there are downsides.
First off – Who else but Warren Buffett has the financial resources to really pump money into a scheme like this. Keep in mind that Buffett just purchase a big chunk of Goldman Sachs – one of the few financial companies to, so far, come out of all of this mess with its balance sheet in tact. I’m thinking GS is going to be purchasing a lot of these distressed assets whether they get a Treasury fund boost or not. But what a sweet deal for GS if they do.
Second – the average person really isn’t going to be in a position to really take advantage of this deal. So while the proposed plan is a good one, its not one that is going to benefit the average investor, and in a number of cases I could envision that those small investors that do try to take advantage are probably going to be put into an ultra-high risk scenario as the ongoing maintenance costs are something more effectively managed on a larger scale – not in quantities of twos or threes.
Still – its a good suggestion by Buffett. I could see a number of players potentially lining up to develop asset management firms for the purposes of buying these distressed properties. Essentially leveraging multiple smaller accounts to create a pool of investment real estate which can be managed at a lower overall effective cost. Even at a 50:50 split between private investment capital and Treasury money I feel that this probably represents a very effective means of managing the financial risk of the bailout assuming that the US financial system’s house is eventually put in order over the next 12 months. – Big if.