The Snowball

by Alice Schroeder

  Yet despite their different approaches, Munger regarded Buffett as the king of investing, and saw himself as merely a friendly pretender to the throne.27 “Vivian, get me Warren!” he shouted several times a day to whichever secretary had come to occupy Vivian’s desk.28 He cultivated Buffett like a garden he was tending. Buffett explained his philosophy: “You’ve got to coattail,” he said.29 But he did not want his friends to coattail him and considered it unethical when they did. Hence, while Munger, cultivating Buffett, was open about his trades—he got Buffett into his British Columbia Power deal, for example—Buffett always kept his trades to himself unless he was working an idea with a partner.

  By the early 1960s, the Buffetts had begun to vacation in California, so that Warren could spend more time with Graham and Munger. Once Warren and Susie took the kids on a long trip up and down the coast, but usually when they came to visit, they’d settle into a motel on Santa Monica Boulevard, and he and Munger would talk stocks for hours. The differences in their philosophies made for long conversations. While Buffett made many of the same investments, he would forgo the chance of profits any day to avoid too much risk, and viewed preserving his capital as an almost holy imperative. Munger had the attitude that unless you were already wealthy, you could afford to take some risk—if the odds were right—to get rich. His audacity put him in a different category from all the others who cultivated Buffett, for his deference to Buffett was limited by his high opinion of himself. “Charlie would get so excited by his own words that he’d hyperventilate,” says Dick Holland, Buffett’s friend and partner, who was present at some of these California get-togethers.30

  In his quest for the great businesses, Munger did not understand Buffett’s fascination with Ben Graham. “Because he is good at explaining Ben Graham,” Munger later wrote, Buffett was “behaving like the old Civil War veteran who after a few minutes of ordinary conversation always interjected: ‘Boom Boom, that reminds me of the battle of Gettysburg.’”31

  Graham’s flaw, Munger felt, was that he considered the future “more fraught with hazard than ripe with opportunity.” Graham was a man, he said, “whose favorite story is that of Croesus, surveying the ruin of his life and empire after the too-hopeful misadventure with Persia, and recalling the words of Solon that ‘no man’s life should be accounted a happy one until it is over.’”32 Munger began trying to wean Buffett away from Graham’s dreary pessimism, which underlay the drudgery of stooping for cigar butts and sucking out their last puff.

  Buffett had a buoyant optimism about the long-term economic future of American business, which had enabled him to invest in the market against his father’s and Graham’s advice. Yet his investing style still reflected Graham’s doom-laden habits of looking at businesses based on what they were worth dead, not alive. Munger wanted Buffett to define the margin of safety in other than purely statistical terms. In doing so, Munger was working against a subtle tendency toward catastrophism in Buffett’s outlook that sometimes cropped up when solving theoretical problems. His father, Howard, had always prepared for the day the currency became worthless, as if that day were imminent. Warren was far more realistic. Nonetheless, he tended to extrapolate mathematical probabilities over time to the inevitable (and often correct) conclusion that if something can go wrong, it eventually will. This style of thinking was the proverbial double-edged sword: It made Buffett a gifted visionary whose thoughts oriented toward doomsday. He would come to use this sword often to slice through knotty problems, sometimes in a very public way.

  A few years earlier, another friend of Buffett’s, Herb Wolf of New York Hanseatic, an over-the-counter trading house, had helped Buffett tame another personality trait that was hindering his financial quest. Wolf, an investor in the water utility American Water Works, had sought Buffett out in the early 1950s after reading an article that Warren had written on IDS Corporation in the Commercial & Financial Chronicle.33

  “Herb Wolf was one of the smartest guys I ever met. He could tell the effect on American Water Works’ earnings if somebody took a bath in Hackensack, New Jersey. He was unbelievable. One day Herb said to me, ‘Warren, if you’re looking for a gold needle in a haystack of gold, it’s not better to find the gold needle.’ I had this thing that the more obscure something was, the better I liked it. I thought it was a treasure hunt. Herb got me out of that way of thinking. I loved that guy.”

  By 1962, Buffett had shaken off the treasure-hunt way of thinking. But he still had Wolf’s passion for detail, and even with the addition of Bill Scott, his operations had expanded so much that he now needed another employee to assist him. He managed to keep this one off his own payroll; Buffett would forever go to extremes to control his overhead by paying for expenses in ways that could be shut off as needed, or, better yet—as in this case—could be covered in ways that made them effectively free.

  Henry Brandt, Buffett’s stockbroker friend who worked at Wood, Struthers & Winthrop, was a born sleuth who had been doing part-time research for the BPL partnership. Buffett had been paying Wood, Struthers for Brandt’s time through the brokerage commissions he paid for trading stocks through it. Since he would be paying commissions to somebody anyway, Brandt effectively worked for him for free.34 If Buffett decided he did not need Brandt’s research anymore, he could use another brokerage firm to execute his trades.

  Now, Brandt worked for Buffett almost one hundred percent of the time. Buffett paid Brandt by waiving his partnership fee and beginning to cut him in on outside deals without an override. The two men shared an interest in knowing the minutest details about a company. Brandt was fearless about asking questions. Unlike Buffett, he never thought twice about making himself obnoxious if this was what it took. He gladly did enormous amounts of meticulous research by gumshoeing and pestering people. Brandt, however, was incapable of stopping before he found the gold needle. Therefore, Buffett set the agenda and steered the process to keep it from turning into a treasure hunt. Brandt produced foot-high stacks of notes and reports.35

  Part of Brandt’s job for Buffett was finding scuttlebutt, a term used by investment writer Phil Fisher, the apostle of growth, who said that many qualitative factors like the ability to maintain sales growth, good management, and research and development characterized a good investment.36 These were the qualities that Munger was searching for when he spoke of the great businesses. Fisher’s proof that these factors could be used to assess a stock’s long-term potential was beginning to creep into Buffett’s thinking, and would eventually influence his way of doing business.

  Buffett now had Brandt digging into an idea that would have pleased Munger, had he known about it. The episode that resulted would become one of the high points of Buffett’s career. This opportunity had its roots in the machinations of a big-time commodities trader, Anthony “Tino” De Angelis, who had become convinced in the late 1950s that he’d found a shortcut to making money in soybean oil. De Angelis—who had a shady past, having once sold tainted meat to the government school-lunch program—had by then become arguably the world’s most important and legitimate dealer in soybean oil.

  It apparently struck De Angelis one day that no one actually knew how much oil was in his warehouse. He was using the oil as collateral to borrow from banks.37 As long as nobody knew how much soybean oil was in the tanks, why not goose up the numbers a little bit so he could borrow more money?

  The tanks sat in a warehouse in Bayonne, New Jersey, which was managed by a tiny subsidiary that was an almost invisible part of the gigantic empire of American Express. This arm of the business issued warehouse receipts: documents that certified how much oil was in a tank and could be bought and sold, just like the warehouse receipts for cocoa beans that Graham-Newman had bought from Jay Pritzker in exchange for Rockwood shares.

  After American Express had verified the oil in the tanks, De Angelis and his Allied Crude Vegetable Oil Refining Corporation sold these receipts or used them as collateral to borrow from banks—fifty-one banks. Further
more, American Express stood as guarantor of the quantity of oil behind those receipts.

  As for the tanks, they were connected by a system of pipes and valves, and De Angelis found that the soybean oil could be sloshed and shunted around from one tank to another. Thus, a gallon of oil could pull double or triple or quadruple duty as collateral for a loan. Pretty soon, the loans guaranteed by warehouse receipts were secured by a smaller and smaller amount of soybean oil.

  Eventually, it occurred to De Angelis that, in fact, very little oil was needed. Indeed, just enough to fool the inspectors would do the trick. So the tanks were filled with seawater, and oil was placed inside a little tube that the inspectors used to guide their measuring sticks. They did not notice the difference or think to test a sample from outside the tube.38

  At about that point, dealing in the oil itself was no longer generating enough money to satisfy De Angelis, so he began to trade in the futures market. Futures contracts give someone the right to buy soybean oil at a later date, betting on the price of oil in the future versus the price today. They are like the futures contracts Graham-Newman had sold to lock in the price of cocoa beans. For a buck or two per ton, De Angelis could buy tons of soybean oil to be delivered in nine months at a certain price to be paid on that date. The contracts could be sold before the payment came due, which made speculating in oil much cheaper than paying twenty dollars to buy the oil outright in order to sell it later. Thus stretched, the borrowed money went much further; De Angelis could, through the futures market, control a great deal of soybean oil.

  The people at American Express had not been entirely asleep; after an anonymous tip in 1960 that something was amiss down in New Jersey, they made inquiries of De Angelis and his employees. But De Angelis, who was as tubby as the tanks full of seawater sitting there right in front of the investigators’ eyes, managed to give them answers that apparently satisfied them.

  In September 1963, De Angelis saw a chance to make a further killing. The Soviet sunflower crop had failed, and rumors spread that the Russians would have to turn to soybeans for oil. De Angelis decided to corner the soybean market, forcing the Communists to buy from him at an inflated price. There was no particular limit to how many soybean futures he could buy. In fact, he could and did control more soybean oil than actually existed on the planet39 by borrowing heavily from Ira Haupt & Co., his broker, and taking on obligations in the futures market to buy 1.2 billion pounds of soybean oil. But this large a bet meant that he could afford to have the price of soybean oil go in only one direction—up.

  Then, suddenly, it appeared that the U.S. government might not let the Soviet deal go through. The price of soybean oil collapsed, driving the market down by $120 million. Haupt began calling on De Angelis to meet his obligations, but De Angelis sent excuses instead. When Haupt came up short of money, the New York Stock Exchange shut the firm down and Haupt was forced into bankruptcy.40 De Angelis’s lenders, holding the now-worthless warehouse receipts, hired investigators and turned to American Express, issuer of the receipts, to recoup their $150 to $175 million in losses. And American Express—caught holding tanks full of nothing but worthless seawater—saw its stock plummet. The story began to hit the newspapers.

  Two days later, on Friday, November 22, 1963, President John F. Kennedy was assassinated while riding in a Dallas motorcade.

  Buffett was downstairs eating lunch in the Kiewit Plaza cafeteria with an acquaintance, Al Sorenson, when somebody came in with the news that Kennedy had been shot. He went back upstairs to his office and found that the New York Stock Exchange floor was in a state of stupefaction; stocks were plunging on heavy trading. With the Dow down twenty-one points in half an hour, the market had lost $11 billion.41 Then the exchange closed, its first emergency closing during trading since the Great Depression.42 Shortly afterward, the Federal Reserve made a statement of confidence that meant—after translation from Fedargot to English—that international central banks would work together to thwart speculation against the dollar.43

  As a stunned country erupted in sorrow, anger, and shame, schools were dismissed and businesses shut their doors. Buffett went home to sit, along with the rest of the country, and watch the nonstop television coverage throughout the weekend. He characteristically displayed no powerful surge of emotion, rather a detached gravity. For the first time in history, a U.S. presidential assassination was being covered on television around the globe. For the first time, shock and sorrow united the world through the medium of television. For a brief while America stopped thinking about anything but the assassination.

  The newspapers, of course, relegated the American Express scandal to their back inside pages for days as the dramatic headlines took precedence.44 But Buffett went looking for it. The stock never recovered from the blow it took on Friday when the market closed, and afterward it continued to slide downhill. Investors were fleeing in droves from the stock of one of America’s most prestigious financial institutions. Its price had been cut in half.45 Indeed, it wasn’t clear whether American Express would survive.

  The company was an emerging financial powerhouse. Now that the average person could suddenly afford air travel, half a billion dollars of the company’s Travelers Cheques floated around the world. Its credit card, launched five years earlier, was a huge success. The company’s value was its brand name. American Express sold trust. Had the taint to its reputation so leaked into customers’ consciousness that they no longer trusted the name? Buffett started dropping in on Omaha restaurants and visiting places that took American Express cards and Travelers Cheques.46 He put Henry Brandt on the case.

  Brandt scouted Travelers Cheque users, bank tellers, bank officers, restaurants, hotels, and credit-card holders to gauge how American Express was doing versus its competitors, and whether use of American Express Travelers Cheques and cards had dropped off.47 Back came the usual foot-high stack of material. Buffett’s verdict after sorting through it was that customers were still happy to be associated with the name American Express. The tarnish on Wall Street had not spread to Main Street.48

  During the months that Buffett was investigating American Express, his father’s health declined precipitously. Despite having undergone several surgeries, Howard’s cancer had spread throughout his body. In early 1964, Warren took charge as the de facto leader of the family. While time remained, he had Howard remove him from his will to increase the share left to Doris and Bertie in a trust. The amount—$180,000—was a fraction of his and Susie’s net worth; he felt it made no sense for him to share it when he could so easily earn money himself. He set up another trust for his children so that Howard could leave them the farm to which the Buffett family had planned to flee when the dollar became worthless. Warren would be trustee of these trusts. Howard’s previous will had specified an ordinary wood casket and an economical funeral, and the family convinced him to delete that part.49 One of the most difficult things Warren felt he had to do was to level with his father that he was no longer a Republican at heart.50 The reason, he said, was civil rights.51 Amazingly, however, he could not bring himself to change his voter registration as long as Howard was alive.52

  “I wouldn’t throw that in his face. In fact if he had lived, it would have really constrained my life. I would not have come out against my father politically in public. I can envision his friends wondering why Warren was behaving that way. I couldn’t have done it.”

  Although the family did not talk about Howard’s impending death at home,53 Susie took over much of his care from Leila. She also saw to it that the children took part in their own way. She arranged for them to stand outside his hospital window with a sign that said, “We Love You, Grandpa.” At ten and nine years old, Susie Jr. and Howie understood what was going on. Five-year-old Peter had a vaguer sense of his grandfather’s illness. Susie also made sure that Warren—who had trouble facing illness under any circumstances—went to the hospital every day to see his father.

  As Howard worsened, Warren poured his
attention into American Express. At the time, he had the largest cache of money with which to work that the partnership had ever seen: Its huge profits in 1963 meant that on January 1, 1964, $5 million of new money had come in, and the partnership was already enriched by $3 million of stock gains from the previous year. His own money had exploded: He was now worth $1.8 million. BPL’s capital at the beginning of 1964 stood at just under $17.5 million. During Howard’s last weeks, Warren began to invest in American Express at a hyperactive sprint, pouring money into stock as fast as he could trade, working tirelessly and methodically to get as many shares as he could without running up the price. Only five years before, he had had to scrape and scrounge to find a few tens of thousands for National American. Never before had he invested like this. Never had he put to work anything approaching this much money, and so fast, in his life.

  Through most of Howard’s final few days, Susie was alone with him, often for hours at a time. She both feared and understood pain, but she was unafraid of death and had the strength to sit with Howard even when those around her were falling apart. Her gift for comforting the hopeless and those in misery blossomed, and Leila, devastated, let her take charge. In such close proximity to death, Susie found that the boundaries between herself and the other dissolved. “Many people kind of flee, but for me it was natural,” she said. “It was a beautiful experience to be that physically and emotionally intimate with someone you loved, because I knew exactly what his needs were. You know when they need to turn their head, or you know when they need a little ice chip. You know. You feel it. I loved him very much. And he gave me that gift for myself of knowing, of having that experience, and realizing how I felt about it.”54