In his 2002 letter to Berkshire Hathaway shareholders, Buffett wrote that it sometimes seemed “madmen”6 imagined new derivatives contracts. His pique was prompted by the multiyear-long hangover of losses from derivatives, chiefly credit derivatives, in the GenRe Securities unit. It showed a loss of $173 million, partly due to restating faulty, but standard, derivatives accounting from earlier years. The loss inspired Buffett to call derivatives “financial weapons of mass destruction.”7 His viral sound bite quickly circled the globe. After reading Buffett’s quote in the financial press, one investment banker joked that my book on credit derivatives is “the manual on how to blow up the world.”
Warren Buffett’s letter to me arrived in June 2005, a hectic month. One of my clients was a law firm representing a large money center bank as plaintiff in a securities fraud case involving another large money center bank. The defendants’ lawyers had hired a former chairman of the U.S. Securities and Exchange Commission (SEC) as their expert witness. Earlier, I had written both my expert opinion report and a report rebutting the former SEC chairman’s point of view. I prepared to give a two-day-long deposition to discuss my opinion in the case in which hundreds of millions of dollars had been lost.The defendants had read my work, knew they faced serious trouble, and subsequently changed their strategy. In fact, they sent their most experienced litigator to depose me.
I put Buffett’s letter in my purse to remind myself to respond to it. The morning of the deposition’s first day, I saw the letter and felt a glow of confidence. I am not a superstitious person, but I couldn’t help thinking of the letter as an auspicious sign. I put it in my pending correspondence file and forgot about it again.
The deposition came and went, and the plaintiff ’s lawyers were delighted.“Everyone gets bloody in a battle, but you slaughtered them.” The defendants’ arguments fell apart in the face of the facts, and the case never went to trial. Shortly thereafter, the defendants came to a settlement agreement to the plaintiff’s satisfaction.
At the end of June, I reviewed my correspondence file and read the letter again. Client business would not take me to Omaha, and I was fairly certain Warren Buffett did not need my help.
July 2005 was another busy month: I had focused so much on the securities fraud case that I had a backlog of business, so I took a much-needed week-long vacation to decompress. At the end of July, I reviewed my pending correspondence file, and it contained only one item: the letter.
After rereading the letter on August 1, I wrote a letter in reply and offered three dates, with August 25, five days before Warren Buffett’s 75th birthday, being the earliest of the three:
It is my turn to apologize for being so late getting back to you. . . . . Business isn’t taking me in that direction anytime soon, but I would be happy to fly in for the day—just because I would enjoy doing it . . .
On August 3, I received an e-mail from Warren Buffett through his assistant stating that August 25 would work:
If you can make it for lunch, I would be glad to take you to a place with no décor but good food.
Everyone in the global financial community knew Warren Buffett by reputation, and his name continually popped up in the financial press, but I operated in specialty niches of the industry, and he was just part of the background noise of my world. I hadn’t read any of the books about him, and I hadn’t read the many articles about Warren Buffett, the man. But I had read many of Berkshire Hathaway’s annual reports including Mr. Buffett’s shareholder letters, which I enjoyed very much.
Warren Buffett was already a billionaire at age 60.That in itself was an achievement beyond the reach of all but a miniscule percentage of humans, but his future success dwarfed that accomplishment. Due to the benefits of continued compounded growth off of a greater base of wealth, the bulk of Buffett’s wealth accumulated after the age when most men retire to spend their money.
Throughout my career, I worked with people who eventually met or did business with Warren Buffett. It was as if we attended the same university and he were a popular senior and I a freshman. I was well respected in my field, and was a self-made woman; but Warren Buffett was a financial legend superlatively good at making money for himself and for his shareholders.
In 1987,Warren Buffett and Charlie Munger rode to the rescue of John Gutfreund, the CEO of Salomon Brothers. Their “white knight” investment of $700 million of Salomon Inc.’s convertible preferred stock enabled Gutfreund to fend off Ronald Perelman’s hostile takeover. Perelman, a famous, colorful cigar-loving corporate raider with a reputation for ruthlessness, had already swallowed up Revlon, Sunbeam, Panasonic and other companies in the 1980s. In contrast, Buffett and Munger were not well known, and their lifestyles didn’t provide salacious material for the media frenzy that surrounded corporate raiders.
Initially, Salomon’s preferred stock was an ideal Berkshire Hathaway investment. Buffett never supplied management; he looked for good honest managers, and he thought he had found one in Gutfreund. Things changed in 1991. Paul Mozer, a trader on the Arbitrage Desk, pleaded guilty to felony charges after a government bond trading scandal. John Meriwether, the head of Salomon’s Arbitrage trading desk, told Gutfreund that Mozer had confessed to him. Their failure to immediately come forward compounded the scandal, and neither of them survived the fallout. Buffett was compelled to protect Berkshire Hathaway’s investment. In the summer of 1991, he became Salomon’s reluctant CEO for 10 months. Mr. Buffett’s leadership and reputation for integrity salvaged Salomon’s business, which rapidly recovered. The convertible bonds outperformed the fixed income securities that Berkshire Hathaway had sold in their place, but by 1995, the option to convert to common shares of Salomon stock was worthless. In 1997, Buffett off loaded the investment on Sandy Weil, and Salomon eventually became a part of Citigroup.
I had joined Salomon Brothers’ summer 1985 training class lampooned by my classmate Michael Lewis in his book, Liar’s Poker. Unlike Lewis, I was one of the trainees actually paying attention at the front of the class, but by the time Mr. Buffett served his brief time as CEO, I was no longer working at Salomon Brothers.
After almost 20 years working for Wall Street firms in New York and London, I made my living running a Chicago-based consulting business. My clients consider my expertise the product they consume. I had written books on credit derivatives and complex structured finance products, and financial institutions, hedge funds, and sophisticated investors came to me to identify and solve potential problems.
Although I was an experienced finance professional, I did not focus on value investing.The University of Chicago was steeped in the myth of efficient markets and leaned to theories put forth by eminent economists.Warren Buffett had earned his MBA at Columbia Business School. He became a friend and disciple of Benjamin Graham, and later worked for Graham’s hedge fund. I had read Security Analysis by Graham and David Dodd in 1985, but I had not actively practiced its principles for my own investment portfolio. Around the same time, I read John Burr Williams’ The Theory of Investment Value, and the fourth edition of The Intelligent Investor. My edition includes an introduction by Warren Buffett with a tribute to the late Benjamin Graham as well as Warren Buffett’s 1984 commencement address at Columbia University titled “The Superinvestors of Graham-and-Doddsville.” I remembered both the tribute and the address and reread them in preparation for meeting Mr. Buffett. My focus was chiefly on derivatives and complex securities. While I applied many of the principles of value investing to my analysis of complicated financial products, I did not yet focus on it for my own investments or as a way of looking at the global markets as a whole.
Derivatives are financial bets that something will or will not happen. Any financial investment involves a bet, but derivatives are leveraged bets. For very little money down—sometimes no money down—you can make gobs of money (or lose gobs of money). The part about losing gobs of money is something most investors try hard not to think about. Sometimes investment banks selling the prod
ucts help investors achieve this goal by putting the part about gobs of losses in very fine print buried in hundreds of pages of documents.
Leveraged bets are so popular that there is more money at risk in derivatives than in stocks or bonds. The problem with leverage-driven binge banking is that everyone tends to disgorge assets at the same time, depressing market prices. Financial leverage sometimes moves global markets, and if allowed to get out of hand, leverage can theoretically trigger a global market Chernobyl.
Warren Buffett disproved the theory of efficient markets that states that prices reflect all known information. His shareholder letters, readily available through Berkshire Hathaway’s Web site, told investors everything they needed to know about mortgage loan fraud, mispriced credit derivatives, and overpriced securitizations, yet this information hid in plain “site.”
I knew the financial markets were at great risk—like children playing with matches in a parched forest—but those thoughts were far from my mind on that hot summer morning in 2005 as I boarded the plane for Omaha. I was about to meet a financial legend, the greatest investor who ever lived.
Chapter 2
Lunch with Warren
Thanks for sending along the . . . link, which I had not seen.The next guy will probably name his company Buffett, Bernanke and Tavakoli.
—Warren Buffett
to Janet Tavakoli, August 27, 2007
The day was sunny and clear, and the flight from Chicago only takes a little over an hour. I wondered how a man with Warren Buffett’s enormous wealth would behave. The late Howard Hughes suffered from paranoid schizophrenia attributed to brain damage suffered during self-piloted plane crashes.According to popular legend, he once roared: “I am not a paranoid deranged millionaire. Godammit . . . I’m a billionaire.” A sense of humor is indispensable if one is insanely rich.
My flight got into Omaha two hours before my appointment. I wanted to be on time for lunch.When I told the cab driver the address, he looked confused. I assumed that every taxi driver in Omaha would know the location of Mr. Buffett’s office, but I was wrong. He asked another cab driver for directions, and we were on our way. It was a short ride.
The taxi dropped me off at an unremarkable buff-colored office building. I opened the door and entered what appeared to be a hallway instead of a lobby. A lone security guard sat at a small desk. He seemed to be expecting me, telling me to go right on up to the 14th floor. An elevator was already on the ground floor, and there was no one else in the lobby. I rode up alone.
The elevator doors opened to a vacant hallway. As I stepped off the elevator, I was startled to hear a friendly female voice say: “Janet, make a right and then another right, and go straight ahead.” I quickly looked around. There was no one there, and I didn’t see a camera or a speaker. I did a quick mental review of my actions since entering the building and was relieved I hadn’t adjusted my skirt on the elevator. The voice repeated the instructions, and this time I followed them.
One of Warren Buffett’s assistants sat to the right of the small reception area. There was no one else there. I told her I had arrived early, but I planned to read Paul Erdman’s book Tug of War about the global currency crisis in the mid-1990s. She offered me beverages, and I accepted a glass of water. I had barely taken a sip, when Warren Buffett appeared. He gave me a quick look and said energetically:“Oh, Janet’s here. Show her right in.”
Warren Buffett was taller and trimmer than I expected. He later told me he works out with a trainer three times per week. His famous eyebrows were trimmed—unlike an old Internet photo—and his skin glowed as if freshly scrubbed. He wore a light gray suit and looked as if he dressed for comfort and appropriateness rather than to impress.
He invited me to sit on a sofa while he took a neighboring chair. Plump beads of sweat rolled down my water glass, and I looked around his coffee table in consternation for a coaster or an ash tray. I didn’t want to be known as the person who left a blistering water ring on the smooth surface. Oh that? A calling card from Janet Tavakoli. Noticing my hesitation, Warren retrieved the Wall Street Journal from his desk. He set it down, and said I could put my glass on his paper. I looked down at the paper knowing I was about to make a mess of it. It looked so smooth.Warren Buffett had worked as a paper boy for the Buffalo News and identified the Washington Post as one of the great bargains of the twentieth century for Berkshire Hathaway’s investors. Warren’s love of newspapers is well known, and for more than half a century he has been a loyal reader of the Wall Street Journal. My heart sank at the thought of making a mess of his paper. Had he finished reading it? I looked up, and to my complete surprise, Warren Buffett appeared nervous. He wouldn’t feel comfortable until I accepted his offer of hospitality; he couldn’t relax until I relaxed. I rested my glass and sat down, smiling inwardly.
Then I blundered. In an awkward attempt to lighten the moment, I said:“Some days that is all the Wall Street Journal is good for.”
His head snapped around and he gave me a sharp look. A few seconds passed.“I agree,” he finally said.
But I knew he didn’t mean his comment, and I hadn’t meant mine. What’s more, he knew I didn’t mean it, and I suspected he knew that I knew he didn’t mean his. Judith Martin, the Washington Post’s etiquette columnist, maintains etiquette has been given a bad name by strangers using fake familiarity to make demands on our time, our privacy, and our resources. Genuine etiquette is a useful social tool designed to make others comfortable without sacrificing one’s own rights. Months later, Warren wrote me that he didn’t think he had “studied her advice sufficiently,” but I thought he graduated summa cum laude.
The Wall Street Journal sparked a discussion of how the news media has changed. Stock price quotations are almost instantaneous. There is more financial news today than ever before originating from a wider variety of sources including the Internet.
Warren loves newspapers, recognizing that newspaper ownership confers status and influence out of proportion with economic gain, yet run properly there is also a lot of economic gain to be had. As he talked, Warren mentioned Kay. Kay? My mind raced. Who is Kay? Fortunately, I quickly realized that Warren meant the late Katherine Graham, president and publisher of the Washington Post. Warren said she was “great lady,” a “remarkable woman,” and recommended I read Personal History, her Pulitzer Prize-winning autobiography.
With Kay’s sponsorship and his substantial ownership position, Warren became a board member of the iconic Washington Post. He said she was the least confident person he had ever met, a curious fact given her privileged life, social standing, and accomplishments. In Personal History, Katherine Graham expresses admiration for Warren and expresses her gratitude to him for the tutelage he gave her in financial matters. She relied on him for both professional and personal support, and his mentor-ship was a source of strength, giving her confidence. The otherwise all-male board was initially wary of their friendship and she noticed some sexism: “Tom Murphy [another member of the Washington Post’s Board of Directors] could consult Warren and no one questioned him, but if I consulted him, it seemed to be something threatening and sinister.”1 Often, when men and women have a close business relationship, it is characterized as a Mephistophelean bargain, but when men form a close business relationship, it is just business. Ms. Graham also noticed: “As Warren and I started to spend more and more time together, people’s eyebrows shot up, and I was young enough then for our relationship to become quite an issue.”2 Even a woman of Katherine Graham’s stature and maturity—she was 13 years older than Warren—could not escape petty innuendo; but she did not let it deter her from taking advantage of Warren’s expertise or spoil her appreciation of their friendship.
I could well imagine Warren’s companionable appeal to Katherine Graham, and Warren lights up when he reminisces about Ms. Graham. He seems to enjoy women without enjoying them too much. It is the difference between spending time with an art connoisseur and a cat burglar. One makes you feel as if y
ou are a national treasure; the other makes you feel as if you are about to be snatched and stuffed in a bag, never to be heard from again. For his part, Warren says he admired Kay’s courage and persistence.
Warren recognizes that the news business had changed. He said the Wall Street Journal threw away a golden opportunity to dominate Internet business news. Internet financial news is both instantaneous and less reliable. Newspaper and magazines—even the online versions of legacy print media—often lag behind blogs and certain specialty new services. There are a handful of Internet financial journalists who are every bit as good as the best reporters in the print media, but they are scattered all over the Internet.
Matthew Currier Burden wrote a book about this phenomenon: The Blog of War. The military is having difficulty containing sensitive information as soldiers pour out their stories over the Internet.The day after our lunch, I sent Warren an article written by John Hockenberry, “In Iraq for 365,” from Wired.com. Warren wrote back that he found the blogs on Iraq particularly interesting along with “the potential that it has for changing journalism.”
The blogs of soldiers in Iraq are much more informative than any state-side news media, including television, radio, newspapers, magazines, and other Internet news sources. Warren is keenly interested in that.Traditional channels of information are being bypassed and passed up by direct information from the front lines, something that had never happened before the Internet Age.The accounts from soldiers are more compelling and informed than the so-called “professional” reportage from mainstream media.
Dear Mr. Buffett: What an Investor Learns 1,269 Miles From Wall Street Page 2