Warren Buffett will invest $5 billion in Bank of America Corp, stepping in to shore up the largest US bank in the same way he helped prop up Goldman Sachs and General Electric during the financial crisis.

Bank of America shares rose nearly 26 per cent at one point but gave up most of those gains by early afternoon, standing 10 per cent higher at $7.72. Trade was so heavy that Bank of America shares made up nearly 13 per cent of the composite volume for the entire stock market.

The stock's rise makes the warrants for Bank of America shares that Buffett gets in the deal instantly profitable.

Buffett and Bank of America said he made an unsolicited call to the bank Wednesday morning offering to make an investment. Buffett told CNBC the idea came to him while taking a bath, and the deal was done in 24 hours.

Even though the bank has said it did not need to raise capital, investors widely believed it needed more money and to show it could raise funds easily.

Bank of America has been plagued by fears that bad mortgage loans and legal liabilities from loans packaged into bonds by its Countrywide unit could drag it into tens of billions of dollars in fresh losses that would stretch its capital.

The deal proved again that Buffett has become something of a lender of last resort to the financial system, as he did with Goldman and GE. Buffett's role in aiding the economy and the financial system has become symbolically important, given the lack of policy options left for the U.S. government and the Federal Reserve to stimulate demand.

"This proves to the market that if the bank needs additional capital, which we don't believe they do, but if they needed to calm the market by raising capital, they could do it within 30 minutes with a quick call to Uncle Warren," said Sean Egan, managing principal of Egan-Jones Ratings.

Instant Return

Buffett's Omaha-based Berkshire Hathaway could make out even better financially than Bank of America in the deal.

Berkshire gets warrants to buy 700 million shares of common stock at just over $7.14 per share, with an unusually long 10-year exercise period. One Berkshire holder said the warrants were by far the best part of the deal.

"He could well make a 100 percent return on his investment in a few years," said James Armstrong, president of Henry H. Armstrong Associates. "It's amazing how much a little hug from Buffett is worth these days."

Bank of America will also sell to Berkshire 50,000 shares of cumulative perpetual preferred stock with a 6 per cent annual dividend. Bank of America can buy back the investment at any time by paying Buffett a 5 per cent premium.

It is virtually a mirror of the deal Berkshire did with Goldman in the depths of the financial crisis in fall 2008, except Goldman paid a 10 per cent dividend. The Goldman deal paid Berkshire $15 a second in dividends until Goldman bought out Buffett earlier this year.

"It's a reasonably priced deal for Buffett. It's opportunistic," said Tom Russo, a portfolio manager at Gardner, Russo & Gardner who holds Berkshire shares.

As of June 30, Berkshire had 39 per cent of its equity investments in the financial sector, according to Standard & Poor's.

Bank's Woes

Earlier this month, a $10 billion lawsuit over soured mortgage securities by AIG helped spur fears about Charlotte-based Bank of America's liabilities, as well as questions about how it would pay for more losses.

In recent weeks, investors have sold the bank's shares, worrying that Bank of America might need more capital -- as much as $50 billion by some estimates -- to cope with losses and meet capital rules.

For shareholders who have watched the bank take two government bailouts and saw the government step in earlier this year to block a planned dividend raise, further dilution would have been a bitter pill to swallow.

There is no expectation that regulatory approval will be needed in this case, a regulatory official said.

CEO Brian Moynihan said on Aug. 10 that the bank could add to its capital through earnings and asset sales. His remarks came two days after the bank's shares plunged 20 per cent.

But many were not convinced. On Tuesday, blogger Henry Blodget said the bank could face $100 billion to $200 billion in write-offs and balance sheet issues, a claim the bank denied but one that pushed its shares to lows not seen since early 2009.

"This helps with the credibility gap that I think has existed in the minds of some shareholders," Jon Finger, managing partner of Finger Interests in Houston, said of the Buffett deal. Finger's family sold its bank to Bank of America years ago.

Moynihan has said the bank is targeting a 6.75 to 7 per cent tier 1 common capital ratio by the end of 2013 under the new Basel III rules, which are designed to ensure big banks have enough capital to withstand crises large and small.

The cost of insuring Bank of America debt against default has been rising, but it fell on Thursday after the Buffett deal, down 68 basis points to 305 basis points. That means it would cost $305,000 a year for five years to insure $10 million of debt.

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