Warren Buffett's American Icon call option program

Warren Buffett's American icon call option program... "The September Wringer of 2008"... Paulson's still up... Lehman's magic "rehypothecation"... Gannett taking "precautions"... Lights out on Allied Capital...

Yesterday, Warren Buffett bought $3 billion of General Electric preferred stock with a 10% dividend and a 10% redemption premium. (If GE wants its shares back, it has to pay 10% above Buffett's buy price.)

As with the Goldman Sachs deal, Buffett also gets GE warrants. In this case, Buffett can buy up to 134.8 million GE common shares within five years at $22.25 per share. On the back of the Buffett imprimatur, General Electric is today completing a $12 billion common-stock offering at the same price.

Buffett says the current environment is "economic Pearl Harbor." Blood is running in the streets, and he's buying. He also says he could lose money on Goldman and GE if Congress doesn't pass the $700 billion bailout.

The Senate passed the bailout plan by a wide margin (74-25) last night, throwing the ball back into the House's court. It would be refreshing to see the House's spine remain intact. Failure deserves to fail, and I don't want the United States to end up like Japan.

Buffett must have been waiting 10 years to buy big chunks of large, well-known franchises like GE and Goldman. Makes me wonder who'll be the next American icon to sell Warren Buffett a giant call option with a fat yield and a 10% redemption premium.

We wrote it… Did the Wall Street Journal read it?

Yesterday, Inside Strategist editor Brian Heyliger alerted readers to a potential collapse in REIT giant General Growth Properties (GGP). The company faces a large debt load… and corporate insiders have been dumping stock by the truckload. As Brian put it:

In total, insiders have sold more than $91 million in the month of September. GGP has more than $24 billion in debt. As of June 30, it needs to repay about $5.4 billion of it by 2009. In March, it reduced debt by $490 million, but sold more than 22.8 million new shares to do it… basically reducing existing shareholders' stakes by 9%.

Lear year, GGP only earned $288 million. With commercial-loan defaults rising, it can only mean commercial vacancies are rising… Which means less income for GGP. Its only options will be to refinance, sell assets, or sell more stock.

GGP shares trade at $15. If GGP has to sell more, shareholders will face massive dilution or, another likely alternative, bankruptcy. That's probably why there hasn't been this much insider selling in General Growth in more than 10 years.

The biggest red flag insiders can send an investor is massive selling as a share price is crashing. This is exactly why we're seeing here.

Today, this "red flag" turned into a lot of "red ink." Helped lower by a negative Wall Street Journal story published last night, General Growth shares are down 50%.

Toronto's Globe And Mail yesterday mused, "Perhaps one day, they'll print it on T-shirts: I Went Through the September Wringer of 2008." Not everyone will remember it that way, though...

Our friend Whitney Tilson of T2 Partners had his best month ever. His fund is up double digits for September. He's made big gains on long positions in insurance company Fairfax Financial and Berkshire Hathaway. His newest (publicly disclosed) holding is clothing retailer dELiA's. While T2 is a long-biased fund, it made its biggest money on shorts, including WaMu and Allied Capital.

Porter, Goldsmith, and I are heading to Tilson's Value Investing Congress in New York next week. It's always loaded with profitable advice. If you'll be in town, it's worth stopping by. At the Pasadena Congress earlier this year, Tilson first outlined his bearish thoughts on the mortgage crisis. This year, he's opening the Congress with a double-session presentation on the mortgage crisis. David Einhorn, Bill Ackman, Leon Cooperman, and many others will also be presenting.

You can view the T2 Partners' mortgage presentation here. (You'll also find a special Value Investing Congress discount for Stansberry readers.)

Another hedge fund is still earning its outrageous performance fees this year. John Paulson, who personally earned more than $3 billion after his fund returned nearly 600% last year, is once again trouncing the markets. His Paulson Advantage Plus fund is up 19.44% for the year through August. His other funds are up between 5% and 13%. Some profitable trades include short positions in British banks HBOS, Lloyds TSB, Barclays, and Royal Bank of Scotland.

Paulson runs $35 billion, so assuming an average 9% return this year, his firm will bank $630 million in performance fees. It'll also earn another $700 million in management fees, regardless of performance.

Of course, not every hedge fund is performing so well. The average fund is down 10% for the year – the worst collective performance in a decade. And some can't even access their money. The now defunct Lehman Brothers has frozen its $40 billion in "prime brokerage" assets. (Investment banks often carry out trades and back-office duties for hedge funds – known as prime brokerage.) And a lending practice called "rehypothecation" may allow Lehman to use some of that cash for its own benefit.

Of course, hedge funds with frozen funds can't redeem investors or take advantage of the great trades in the current market. "We are probably going out of business and liquidating, game over," one hedge-fund manager told Bloomberg. Another $1.5 billion hedge fund had to close last week because its money was frozen at Lehman.

Yesterday, a home in Saginaw, Michigan, about 100 miles north of Detroit, sold for $1.75 on eBay – it was the eighth bid. You can see pictures of the home here. Or if you'd prefer to invest in commercial Detroit real estate, several skyscrapers are for sale. You can read about them in DailyWealth.

"Junk" bonds are yielding a record high 11.24% above similar Treasuries – the most since Merrill Lynch started collecting spread data in 1996. While most bond investors are scared of defaults, Mike Williams, editor of True Income, is foaming at the mouth. In Tuesday's Digest, we pointed out that as the government pumps money into the system and the credit crisis starts turning around, the default risk for corporate bonds will decrease, not increase.

If you buy these bonds now, you can collect almost 15% a year to sit and do nothing. As one fund manager put it, you're getting "paid to wait." To learn more about True Income and see our favorite high-yield corporate bonds, click here...

New highs: none.

If you made money last month while everyone else was losing it, write in and tell us how you did it: feedback@stansberryresearch.com.

"Tuesday my wife went to our bank and withdrew $20,000 cash. The bank was less than happy but gave her the money. They asked no questions but said they were concerned because they wouldn't get another cash delivery until next Monday and they might need cash for other customers. I am beginning to wonder if we wouldn't be better to stop using our bank and instead keep our cash at home. They pay only about 1/10th of a percent interest and then are reluctant to let you withdraw cash." – Paid-up subscriber Sheldon

Ferris comment: Reminds me of an academic paper I downloaded last night, a strange piece of work with an excellent title: Fractional Reserve Banking as Economic Parasitism. The fractional reserve system is a fraud. Banks don't want to give you your money because they don't have it. They have maybe 10% of it. There's hardly a bank in the country depositors couldn't shut down by simply trying to take out their money and put it into their own pockets.

"Geez, now I know how the Chairman of G.M. feels. After many angry e-mails, and now feedback replies about my misplacing the decimal point, I must apologize for my mistake. It was just a joke, so I wish people would lighten up. I now realize what a touchy and passionate issue this truly is. So in response, I am going to quit my night job as a wine taster, and only pursue it as a hobby. I have to because I have just accepted a day job at a rather large Wall Street firm in their accounting office." – Paid-up subscriber Tim Spiewak

"As an income investor who has owned Allied Capital stock since 2002 and earned consistent yields above 7 & 8 percent each year, I'm in the dark as to why you applaud this tinhorn, Einhorn who has worked so hard to defame the company – to what end? It will be pleasant to watch the Redlight come on for his baby Greenlight, before too long, and then see it fade to obscurity – talk about the pot calling the kettle Black!" – Paid-up subscriber Bruce

Ferris comment: Let me get this straight: You own a financial stock that's been crushed. You dislike Einhorn because he's right about Allied and you're wrong. You think he's going to lose money shorting garbage. And last but not least: You're in the dark.

Regards,

Dan Ferris

Medford, Oregon

October 2, 2008

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