Buffett's Stake In BofA: What Does Warren Know?

Includes: BAC, BRK.A, BRK.B
by: Ira Stoll

[Editor's Note: 4:30pm ET. Article has been updated by author since initial publication]

Warren Buffett's decision to invest $5 billion in Bank of America might seem unrelated to Mr. Buffett's public policy campaign to raise taxes on the "super-rich," but in fact the two intersect in at least two significant ways.

The first is that it is yet another example of Mr. Buffett structuring his own and Berkshire Hathaway's affairs with special care so as to minimize the taxes that he owes, contradicting his professed desire to pay more taxes.

Bloomberg News reports that in exchange for $5 billion from Mr. Buffett, Bank of America

Will sell cumulative perpetual preferred stock to Berkshire, the Charlotte, North Carolina-based bank said today in a statement. The preferred stock pays an annual dividend of 6 percent, and Omaha, Nebraska-based Berkshire gets warrants to buy 700 million shares at about $7.14 each.

These dividends on preferred stock are 70% or 80% tax-free under the "dividends-received deduction," or DRD. If Mr. Buffett had structured the investment instead as a straight loan from Berkshire to Bank of America at a 6% annual interest rate, the effect would have been close to the same, but Berkshire would have to pay much more tax on the interest.

The second intersection is that some of the risks of buying Bank of America stock are political and regulatory risk. At some point down the road — I am not suggesting in any way that the bank is at this point now — it could be possible that the government could use the resolution authority in Dodd-Frank to seize Bank of America as a systemically important institution, or force it to raise more capital in a way that would dilute its existing shareholders. Or the government could intervene either retrospectively or prospectively in the home mortgage market in a way that would adversely affect Bank of America's business (and also Wells Fargo, another big Buffett-Berkshire holding). Mr. Buffett is close to President Obama, Treasury Secretary Geithner, and Federal Reserve Chairman Bernanke. He's been running around crediting the last two as heroes for saving America and the world from economic catastrophe. President Obama gave Mr. Buffett the Medal of Freedom earlier this year, and Mr. Obama met with Mr. Buffett in the Oval Office on both July 18, 2011 and July 14, 2010. Mr. Obama has been on the campaign trail quoting Mr. Buffett's call for tax increases, and the president even interrupted his vacation to telephone Mr. Buffett, a call for which, as with the two Oval Office meetings, the transcript is not public and has not been released. Mr. Buffett reportedly will host a fundraising dinner in New York for the Obama presidential campaign next month for donors who give between $10,000 and $35,800 a person.

Who else other than Mr. Buffett could have as much confidence that the Obama administration is not going to eradicate the value of his $5 billion investment, and in fact might do what it can to enhance it?