by Addison Wiggin & Ian Mathias

• Buffett’s sudden “all-in wager” on the U.S. economy… Chris Mayer on why to expect more M&A soon
• Stock market fixated on the FOMC… Rob Parenteau explains the Fed’s interest rate conundrum
• The free market lives! Ford announces profit, government forecasts taxpayer loss on GM and Chrysler
• Plus, is financial innovation now taboo? Readers, The 5 weigh in

  Wow, here’s some mud in the bear market’s eye: Warren Buffett just made the biggest acquisition in Berkshire Hathaway history. In his words, “an all-in wager on the economic future of the U.S.”

Buffett’s trump card: Railroads

Undeterred by the moonshot rise in the S&P over the last eight months and the inevitable coming correction, Berkshire Hathaway announced its acquisition of Burlington Northern Santa Fe this morning. In spite of already owning a multibillion-dollar chunk of the railroad company, Buffett will have to pitch in $26 billion and take on $10 billion of Burlington debt to seal the deal. With a total value of $44 billion, it’ll be the biggest buy in Berkshire history. It’s so big that Berkshire can’t pay all cash. 40% of the deal will be financed with shares of BRK. (Berkshire’s B shares will subsequently be split 50-1… soon to truly be Everyman’s access to BRK.)

  “Too many companies sitting around with too much cash and not enough opportunities means we’ll see more deals,” Chris Mayer adds. It’s worth mentioning Chris wrote the following note to his Special Situations subscribers yesterday before Buffett’s announcement:

“The 500 largest U.S. companies -- excluding financial firms -- hold the largest cash hoard as a percentage of assets since 1960. The Wall Street Journal claims that cash hoard was nearly $1 trillion in the second quarter, or about 10% of total assets. So far in the third quarter -- with 248 of the 500 firms reporting -- cash has increased to 11.1% of assets.

“Cash is the financial equivalent of a big, soft pillow. It helps you sleep better at night. After the credit crisis turned small balance sheet leaks into lethal holes, executive suites around the country seem determined not let that happen again…

“But there might be another reason why the bigwigs sit on all that cash. They might just not see many good opportunities to invest in right now. In other words, the piling up of cash in America’s corporate treasuries may just mirror the weak economy.

“However, the market is not a kind or patient place. It doesn’t feel fear for long. The market thrives on risk taking. And there is always someone looking to relieve you of your cash. If you can’t think of something worthwhile to do with it, someone else will.

“In the market, the way to relieve one of cash is often through the ‘rough-hewn evolutionary mechanism’ -- in the words of the late financier Bruce Wasserstein -- of mergers and acquisitions. A takeover solves two problems for an acquirer: What to do with all this cash and how to grow when there don’t seem to be many opportunities to do so.

“I expect we’ll see many more such deals. In our own portfolio, I see several stocks ripe for takeover.”

If you haven’t heard, right now you can get full access to that portfolio, four of Chris’ favorite natural gas plays and a month of Mayer’s Special Situations -- all for just $1. That’s as sweet a deal as we can make… get it here while it’s still around.

  Berkshire Hathaway cut its stake in Moody’s for the third time in three months, a regulatory filing revealed yesterday. While Buffett has never had the stones to admit Moody’s and other major credit raters are a crooked bunch, he’s letting his money do the talking… Berkshire has cut its holdings of Moody’s by over 20% this year.

  Buffett may have saved the U.S. stock market from an ugly sell-off today. After finishing a choppy session yesterday, the S&P rose 0.8%. The index looked ready to give it all back early this morning, but thanks to Buffett’s news, shares are just a bit lower as we write.

  Don’t expect too much market action until tomorrow afternoon, when the FOMC emerges from its latest meeting. Especially in light of another rate hike from the Reserve Bank of Australia overnight, the market wants to know when the Fed plans on abandoning its near-zero interest rate policy.

  “We believe there will be no change in the language,” notes our macro-man Rob Parenteau, “regarding holding the fed funds rate near zero for an “extended period” at the next Federal Open Market Committee (FOMC) meeting, despite the real GDP advance in Q3. The Fed needs home prices to stabilize (if not advance) if further damage to household and bank balance sheets is to be contained.

“We suspect the end of Treasury purchases last week under the Fed’s quantitative easing regime is more important than guessing the precise language of the next FOMC statement, although the auctions during the week, we understand, went smoothly. Still, unless the relapse news builds, or the banks step up their purchases of longer-dated Treasury debt, the Treasury market has just lost a major buyer, as this part of the Fed’s quantitative easing operations has come to a close.”

  Pending home sales rose in September for the eighth month in a row, the National Association of Realtors said today. The NAR’s index of pending sales is now at 110, up 21% from September 2008. By their own admission, the NAR attributes the rise to “a rush of first-time buyers trying to beat the expiration of the tax credit at the end of this month.” Could be interesting if their lobbyists can’t pull off an extension.

  Nine banks with 153 offices and almost $20 billion in assets failed over the weekend. We apologize… we were so tied up in CIT’s failure in yesterday’s 5 we forgot to mention the unraveling of FBOP Corp. The bank holding company lost nine of its subsidiaries late Friday to the FDIC. That will cost the deposit insurance fund an estimated $2.5 billion, which we’ve heard is now almost $8 billion in the red.

That brings the tally to 115 failed banks in 2009.

  Brace yourself -- an American auto company might actually MAKE MONEY this year. Ford announced yesterday that it earned a billion dollars last quarter -- its second profitable quarter in a row and its first profitable quarter in North American sales since 2005. How? Get ready for this stunning innovation as reported by the NY Times: Ford “has turned itself around largely by cutting costs and introducing cars that consumers want to buy, rather than resorting to deep discounts to lure shoppers into showrooms.”

Of course “cash for clunkers” played an enormous role, but it’s cool to see the one American automaker not on Uncle Sam’s bailout payroll turn a profit. The free market lives on…

Heh, and naturally, the UAW cited Ford’s third-quarter profitability as the main reason why it rejected the latest round of labor concessions. Their statement said the quarterly success was “evidence of the contributions that Ford workers have made,” and thus proof that they aren’t compensated and protected adequately. Oy…

  The U.S. government is “unlikely to recover” its $80 billion investment in GM and Chrysler, the Government Accountability Office suggested in a report yesterday. The GAO’s latest report claims the two companies would need to grow to a combined market cap of $121 billion for the Treasury (read: taxpayers and Chinese) to break even. No saying how much either company is worth now, as they aren’t publicly traded… but at their peaks, their combined market value was $94 billion.

  “Edmunds' numbers appear to only take into account the $4,500 cash,” a reader writes, this one referring to the Edmunds report from last week that suggested the U.S. taxpayer paid $24,000 for each “cash for clunker” trade in.

“Administrative costs for the program? Interest on each of those $4,500 payments over how many years? Hidden costs will likely boost the ‘costs’ by a factor of three or more. Have you ever known any government program to cost less than triple their budget in the final analysis? Thus, we can guess that each of those cars sold is going to hit the taxpayers' wallets for more like $75,000 each. Can anyone say ‘Porsche’? or ‘Beemer’? or...?
 
“And we still haven't calculated the costs of all the wasted labor and materials that went into the clunkers to begin with.”

The 5: That’s all certainly possible. And what about brand loyalty? We know a whole slew of people traded in their American clunker for a Toyota or a Honda. But what about the next time they buy a car? Or when they buy one for their kids? Think about it long enough and one could make the argument that “cash for clunkers” derailed generations of auto sales for U.S. manufacturers.

  “You said, ‘Innovation in the financial markets is needed most,’” a reader writes, referring to our whining about the proposed “Financial Services Oversight Council.”

“I submit that innovation is one of the primary causes of the crises, and less, not more, innovation is needed. Banks, etc., should get back to traditional mortgages and financial products and stop trying to make money out of crap…”

  “Oh puleahse,” another reader objects. “You should know better than trot out that old harridan. We don't need banks to innovate. We need them to become tame and boring again!”

The 5: No, we think innovation is very much needed in the financial sector… just not the kind of innovation we’ve become accustomed to. At the risk of sounding cheesy, our partners at EverBank and their MarketSafe CDs are a good example. Who’d have thought 10 years ago that an average person with a few thousand bucks could gain exposure to precious metals or multiple foreign currencies without jeopardizing their principal investment? That’s pretty cool. This editor has a checking account with ING that is entirely electronic -- if you need a check from me, I can just go on any computer or smartphone and have the bank mail it to you on my behalf or deposit it directly into your account.

What about ATMs? ETFs? Cheap online brokerages? PayPal? Mutual funds? Live tickers and the proliferation of investing information? Options? Debit cards? We’d rather take our chances with financial innovation… and keep a close eye on the innovators.

"It's amazing to me,” Addison Wiggin chimes in, “how quick people are to abandon the free market when the s*^t hits the fan. Not Free Market in the political bandwagon sense pushed by the neocons, but the actual free market that produces higher and higher standards of living over time.”

Cheers,

Ian Mathias
The 5 Min. Forecast

P.S. Right as we were about to publish, gold hit a record $1,080 an ounce. Rest assured we’ll have the full report tomorrow once the dust as settled. Stay tuned.

P.P.S. If you’re trading currencies or looking to start, you can’t miss this: Our currency trader Bill Jenkins’ Seven Master Forex Secrets.