This baroque system had successfully financed the U.S. government debt since World War I. In 1990, the Treasury auctioned $1.5 trillion of bills, notes, and bonds. The single hitch had occurred in 1962, when a Morgan banker bid for half of an auction of T-bills. The Treasury Secretary feared an attempt by Morgan to corner the market; for obvious reasons, the Treasury did not want to become dependent on only a few dealers.25 After that, it imposed a 35 percent limit on awards to each account.
Usually, winners did not get that much, since awards were prorated. But the canny Mozer found a loophole. Recognizing that awards were limited to 35 percent but bids were not, he submitted a bid in June 1990 for double the total of notes on auction. Even after prorating, Mozer got the lion’s share.
Michael Basham, the white-shirted mandarin who was in charge of the Treasury auctions, immediately called Mozer and told him not to do it again.26 Not surprisingly, he assumed that was the end of it.
But two weeks later, at a $5 billion bond auction, Mozer submitted a bid for $10 billion. Basham was stunned; he could not believe that a dealer would openly defy the U.S. Treasury, much less the dealer that had been partaking of its lamb chops for three-quarters of a century. Rejecting Mozer’s bid, Basham proclaimed that bids, too, would be limited to 35 percent.
Mozer, as Charlie Munger would say, now began to exhibit delusional behavior. He threatened to go above Basham to the Treasury Secretary. Then he squawked to the press—a breach of the gentlemanly code that infuriated the Treasury. Now alarmed, Salomon higher-ups arranged a breakfast with Robert Glauber, the Treasury undersecretary for finance, intending for Mozer to apologize. But Mozer couldn’t pull it off; he affected an aggrieved air.27 Salomon was so concerned that it ordered him to ring back and say he was sorry. Then Mozer was shipped to London for a brief cooling off.
But Mozer was in deeper than Salomon knew. At an auction in July and again in August, Mozer had inflated his awards by bidding on behalf of customers who had not, in fact, authorized him to do so.28
Then, in December 1990, at an auction of four-year notes, Mozer submitted a phony $1 billion bid on behalf of a customer, Mercury Asset Management. A clerk was told, either by Mozer or by a Mozer deputy, to “sell” the bonds from the unwitting Mercury’s account to Salomon, as though Mercury had really bid for the bonds and later sold them. To cover Mozer’s tracks, the clerk wrote “No Confirm” on the trade ticket, so that Mercury would not be advised of the trade.
Continuing in this pattern, in February 1991 Mozer submitted 35 percent bids for two customers—Quantum Fund and Mercury—again without authorization, as well as a genuine bid for Salomon. Salomon and its “customers” were awarded 57 percent of the auction.
The Treasury, of course, had no idea that all of the bonds were going to one party—in explicit violation of its rule. But in April, a Treasury official reviewing the auction sent a routine housekeeping letter to Charles Jackson, a Mercury executive. A copy was sent to Mozer. One may imagine his alarm. The letter referred to Salomon’s bid in February “on behalf of Mercury Asset Management.” Mercury knew of no such bid.
Desperate to cover himself, Mozer called Jackson, coyly telling him that the bid was the result of an error by a clerk, which Salomon was correcting. He asked Jackson not to embarrass him by responding to the Treasury. Jackson let it pass.
To play it safe, Mozer told Meriwether that he had submitted a single false bid, and described his effort to hush it up. Meriwether, who was stunned, said it could end Mozer’s career.
“Is there anything else?” he inquired.
Mozer lied. He said it was the only time, and begged for another chance.
A few days later, on April 29, Meriwether huddled with Gutfreund, Salomon president Thomas Strauss, and general counsel Donald Feuerstein in Salomon’s new headquarters, a massive pink-granite-and-glass spire in the shadow of the World Trade Center.29 Gutfreund was shocked by what he heard.
“How could you misuse a customer’s name?” he wondered.30
Meriwether defended Mozer as a hardworking manager who had goofed. Yet they knew that Mozer’s behavior was not completely isolated. There had been his perverse battle with Basham, which the group discussed, and his outburst at the company auditor.
Feuerstein said the false bid probably was criminal. Though not required to do so, Salomon should report it, he thought. But Gutfreund hesitated. He belabored the issue of whether to report to the Treasury—an unpalatable option, in light of the Mozer-Basham spat—or to the Fed. A phone call right then to Gerald Corrigan, president of the New York Fed, would have ended the matter. But perhaps they could break the news more gently in a personal visit. The group agreed that Mozer’s misstep should be disclosed, but didn’t decide who would do it or when. Remarkably, Mozer was left in charge of the government desk.
Anyone else in Mozer’s shoes would have operated discreetly, at least for a while. But discretion was not a part of Mozer’s playbook. In May, at an auction of two-year notes, Mozer bid an unexpectedly high price and was awarded an astonishing $10.6 billion worth, or 87 percent, to be split among Salomon and two Salomon customers. This was clever, but too clever.
Many other dealers who had commitments to deliver the notes could not get hold of them. They were “squeezed.” This set off a scramble for the “May two-years,” and the price soared. Mozer made about $18 million on the squeeze (in addition to $4 million or so from his earlier, phony bids).
But traders complained—loudly and, in some cases, directly to Washington—that Salomon had cornered the market. Squeezes are not illegal unless a trader conspires to manipulate prices. Nor are they uncommon. But the squeeze in May triggered widespread losses and put a few traders out of business.31
The Treasury still knew nothing of Mozer’s false bids, but Basham and his colleagues had been watching Mozer. Now, to Basham’s amazement, he saw what looked to him like a brazen attempt to manipulate the market by the Treasury’s supposed partner.32 Just before Memorial Day, he tipped off the SEC.
As Washington busied itself with cherry blossoms, its investigative machinery quietly began to churn. The SEC and the Justice Department secretly began a probe of Salomon’s role in the squeeze.33 Subpoenas went out to Salomon’s clients.
Meanwhile, the Treasury was getting heat from Rep. Edward J. Markey, a subcommittee chairman who had heard griping from traders. The Massachusetts Democrat was preparing a bill to tighten supervision of the Treasury market.
Stephen Bell, Salomon’s profane but effective Beltway lobbyist, was worried about the legislation. When Bell saw press reports of a squeeze, he knew it was trouble.
Dialing Salomon’s government desk, Bell, a New Mexican given to cowboy boots, hollered into the phone, “What the fuck is this?”34 Mozer said Salomon had done nothing wrong. For nothing, Bell thought, Washington was pretty upset.
Early in June, at Bell’s urging, Gutfreund paid a courtesy call on Glauber, the Treasury undersecretary. Despite repeated reminders from Salomon’s lawyer,35 Gutfreund still had not disclosed the phony bid. But to do so now, when the Treasury was concerned with the squeeze, would have been … well, awkward. Sitting stiffly, under the gaze of Glauber’s dark oil portraits, Gutfreund defended Salomon’s behavior and offered to be helpful. He did not mention that the head of his government desk had lied to the Treasury. Glauber wondered why he had come.36
Gutfreund may have hated to blow the whistle when Salomon, finally, was enjoying a revival. And he now had the matter of explaining his own delay. Like a witness who is too long silent, he began to act as though he himself were guilty. He still intended to disclose the bid, he confided to Strauss, but he contended that it was a “minor” matter.37 Incredibly, it did not occur to him that the U.S. Treasury, Salomon’s oldest and most valued partner, might see matters differently.
Then, late in June, Gutfreund learned that Salomon was the target of a civil—and a criminal—probe. He promptly hired the law firm Wachtell Lipton Rosen & Katz to investigate
Salomon’s behavior in the squeeze. Yet he didn’t tell Wachtell Lipton about Mozer’s false bid. Gutfreund was still tiptoeing, even with his lawyer. Only on July 12, when a Wachtell Lipton attorney found evidence of false reporting, did Salomon come clean.38
During the next month, Wachtell Lipton uncovered six bidding violations. Marty Lipton, the firm’s senior partner and a Gutfreund confidant, also advised Gutfreund that he had no obligation but should make disclosure anyway. Gutfreund agreed. In his own mind, he was doing—and had done—the right thing. He expected, if not congratulations, at least a muffled approval.39
On Thursday, August 8, Salomon gave its directors the news. They got hold of Buffett at an outdoor pay phone, next to a restaurant in Lake Tahoe.40 What little Buffett heard didn’t overly concern him. Munger, who was dining at his cabin in Minnesota, pushed harder for an explanation.41
The same night, Gutfreund and Strauss made the long-delayed call to Corrigan at the New York Fed, giving him a sketch of Wachtell Lipton’s findings and mentioning that they had known of one false bid for a while. Corrigan was cool. Gutfreund made similar calls to SEC chairman Richard Breeden and to Glauber.42
On Friday, Salomon went public with a press release. But the Wachtell Lipton attorneys, who wrote the release, had picked up the habit of tiptoeing. They failed to mention that Gutfreund and Strauss had known of an illegality for months. What the release did say it said confusingly and incompletely. Nor did Gutfreund say more to the staff. Salesmen and traders left for weekend homes with the reassuring thought that the matter was contained to Mozer and his deputy, who had kept his knowledge of a false bid quiet. Both had been suspended.
On Monday, August 12, the tone changed. The Wall Street Journal focused on the purported roles of Gutfreund and Strauss:
Said one person familiar with the firm: “It’s hard for me to believe—it’s inconceivable—that [Salomon’s management] wouldn’t know how much was bid for.”43
The implication that Gutfreund had been in on the bidding was incorrect. But reading those words, Gutfreund rightly sensed that the spotlight would shift from Mozer to himself.
Immediately, he summoned Deryck Maughan, who chaired a Monday meeting of Salomon’s investment bankers, and William McIntosh, who ran the weekly sales meeting. Gutfreund told the two to reassure the troops that the problem was “contained.” Maughan and McIntosh did as told. But it was not contained. Salomon’s stock opened lower. Worse, traders began to back away from its commercial paper, the short-term IOUs that Salomon depended on to fund its operations.44
By the end of the day, markets were awash in rumors. McIntosh confronted Gutfreund and Strauss again; now they admitted that there were more violations—and that they had known of one since April. McIntosh, a balding veteran of thirty years, boldly suggested that Gutfreund resign.45 Gutfreund refused, but allowed that if McIntosh thought he could write a better, second press release, to give it a try.
On Tuesday, McIntosh called Maughan. “Deryck, I found something out and I’m terribly uncomfortable,” McIntosh began. “You’re the one person I can trust.”46
Maughan, a Britisher, had built Salomon’s Tokyo office into a major profit center. He had recently been called back to New York to revive the corporate finance department. A coal miner’s son, educated at the London School of Economics, the forty-three-year-old Maughan was already thought to be Gutfreund’s likely heir.
The day before, Maughan had vouchsafed for Gutfreund’s integrity. Now both he and McIntosh felt they had been sandbagged. His cheeks reddening, Maughan called Zachary Snow, a Salomon attorney who worked for Feuerstein.
“Zack, I need to talk to you. I need facts. If you don’t come, that’s a message.”
Meanwhile, a letter from the Fed was being hand-delivered to Gutfreund. Corrigan also needed facts—and hinted that Salomon’s primary dealership was in jeopardy. Alarmed, Gutfreund and Strauss called Corrigan, and found him in an unfriendly state. The beefy central banker was furious that a scandal had broken on his watch. Even during that call, Corrigan felt that he was getting the facts “in dribs and drabs.”47 He is said to have huffed at Strauss, “How could you do this to me?”
Salomon’s brass regrouped Tuesday night at Wachtell Lipton. Amid some heated arguing over Gutfreund’s culpability, the executives drafted a second press release. This one weakly admitted that “senior management” had had prior knowledge. Then Munger came on the line and said, “Let’s not just say ‘senior management.’ Let’s say who!”48 That settled it.
A week before, Gutfreund had been Wall Street’s most feared executive. By Wednesday, his career hung by a thread. The disclosure that he had known of a violation in April—and had left Mozer in place for further mischief—set off a chain reaction. In the minds of regulators, lawyers, reporters, and Salomon’s own employees, the firm began to resemble the still-fresh corpse of Drexel Burnham, which had collapsed after a lengthy battle with the government the previous year.
On Thursday, customers began to desert. The Wisconsin investment board cut Salomon off. Moody’s announced a possible downgrade. Corporate clients told Salomon not to bother calling until they saw a change at the top. Gutfreund, who was cloistered with loyalists on the forty-third floor, had become a leper.
Thirteen floors below, the closely cropped Maughan was issuing makeshift orders like a platoon sergeant cut off from his command. But Maughan could not calm markets. Salomon’s stock had dropped from 37 to under 27 in a fortnight. The bond market, too, had turned on its former king. Salomon’s medium-term paper had plunged from 60 points off the Treasury curve to 300 points off.49 Its credit was unraveling. People were telling Maughan that he had to call Buffett—whom he had never met.
On Thursday night, Corrigan and Gutfreund spoke again. This time, Corrigan made it clear that he was preparing to yank Salomon’s status as a primary dealer.50
People in high places, especially those with pieds-à-terre in Paris, may find it hard to fathom that the bell can toll for them. Certainly, Gutfreund had never imagined that he could be jeopardized by Mozer’s petty machinations. But without Corrigan, he doubted that he could go on.
On Friday, Gutfreund awoke to see his picture atop the New York Times. It occurred to him that he was looking at his obituary. At six-thirty, he phoned Corrigan, who did not discourage him from quitting. Then he called Lipton, who was shaving. Lipton, always eager to help his friend—though Salomon, not Gutfreund, was his client—pleaded with him to reconsider.
The once and sometime king sped to his office. Shortly before seven, Omaha time, he called Buffett at his home, waking him. Gutfreund said he had decided to quit—it was his decision alone—and wanted Buffett to step in.
Buffett hesitated. He had always been careful to avoid such entanglements. In Omaha, he had his life neatly arranged. Once, when Tom Murphy was on the verge of acquiring ABC, Buffett had cautioned, “Think about how it will change your life.” Undoubtedly, he now had the same thought about himself.
“You got to come to New York,” Gutfreund insisted. “I just read my obituary. Look at the paper.”
“Well, let me think about it.”51
Buffett showered, dressed, and cruised the familiar route to Kiewit Plaza. In his mind, he ran through Salomon’s balance sheet. He knew that it had $150 billion or so of assets, only $4 billion of which was equity. Salomon had more liabilities than any company in the United States save Citicorp. Then Buffett began to think about Salomon’s intangibles. The business was making money—as a business, it wasn’t going broke. The crisis was that top management was being eliminated overnight, in a business where confidence is enormously important.52 The directors would be meeting Sunday to accept Gutfreund’s and Strauss’s resignations. They would need someone to take the reins.
Buffett’s confidants were skeptical as to whether he should do it. Ron Olson, his lawyer at Munger, Tolles & Olson, warned that it was “a very high-risk proposition,” and that Buffett’s reputation would be forever damaged
if it turned out badly.53 Howie prophetically told his father, “Everybody who ever wanted to take a shot at you is going to do it now.”
The safe course would be to give Salomon a quiet burial. True, Buffett had a $700 million investment in Salomon preferred. But the preferred stock was far safer than the common; neither Munger nor Buffett thought they would lose much money in a liquidation.54
But Buffett stood to lose something nonetheless. His entire career, he had argued for a sort of compact between shareholders and corporations. Gutfreund had failed the trust, through weakness and hesitation. But the compact worked both ways. As Salomon’s biggest owner, Buffett also had responsibilities. He had a duty, which at the extreme resembles fate.
By midday, Buffett was aloft in the Indefensible, racing toward New York.
For most of that Friday, trading in Salomon’s stock was halted. Its ordinary business stopped. The top executives huddled in the boardroom. Gutfreund came in at noon and said, “Warren is the CEO.” The others hung around, waiting. According to Maughan:
The whole firm had put down their phones. They knew there was a meeting of the office of the chairman going on. We had this curious suspended animation while we were waiting for the CEO to get here on his plane.
The executives knew they were days, perhaps a week, from seeing the firm go down the tubes. They were beady-eyed and stale from too many meetings. Donald Howard, the chief financial officer, said, “We were in a state of shock.”
Late in the afternoon, Buffett poked his head into the boardroom and gave a hearty “Hi there.” He managed a joke about “the little problem we have,” as though the firm had lost a valued attendant in the mailroom. Thinking aloud, he added, “I’m really sorry about John and Tommy. Is there any way we can save JM [Meriwether]?”55
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