The Snowball

by Alice Schroeder

  Susie Jr., Howie, and Peter were sitting at the kitchen table one evening when their father came in, looking more depressed than they had ever seen him. “I’m going to Grandma’s house,” he said. “Why?” they asked. “Aren’t you going to the hospital?” “Grandpa died today,” Warren said, and walked out the back door without another word.

  “I thought, we don’t want to talk about this,” Susie Jr. recalls. “This was going to be so big that talking about it was too painful.” Big Susie represented the family in planning the funeral, while Warren sat at home, stunned into silence. Leila was distraught, but she anticipated her reunion with her husband in heaven. Susie tried to get Warren to explore and express his feelings about his father’s death, but he literally could not think about it, fending it off with anything else available. Falling back upon his core of financial conservatism, he argued with Susie that she had been conned into spending too much money on Howard’s coffin.

  On the day of the funeral, Warren sat in silence through the service as five hundred people mourned his father. No matter how controversial Howard Buffett’s views had been during his life, people came out to show respect for him in the end. Afterward, Warren stayed home for a few days.55 He parried unwelcome thoughts with the distraction of watching Congress debate landmark civil rights legislation on television. When he returned to the office, he continued buying American Express at a hectic pace. By the end of June 1964, two months after Howard’s death, he had put almost $3 million into the stock; it was now the partnership’s largest investment. Although he never did show any visible sign of grief,56 eventually he placed a large portrait of his father on the wall across from his desk. And one day, weeks after the funeral, two bald patches appeared on the sides of his head. His hair had fallen out from the shock.

  27

  Folly

  Omaha and New Bedford, Massachusetts • 1964–1966

  Six weeks after Howard died, Warren did something unexpected. It was not just about money anymore. American Express had done wrong, and he thought that the company should admit it and pay for the damage. The company’s president, Howard Clark, had offered the banks $60 million to settle their demands, saying the company felt morally bound. A group of shareholders sued, arguing that American Express should defend itself rather than pay. Buffett offered to testify on behalf of the management’s plan to settle, at his own expense.

  “It is our feeling that three or four years from now, this problem may well have added to the stature of the company in establishing standards for financial integrity and responsibility which are far beyond those of the normal commercial enterprise.”

  But American Express wasn’t offering the money to be an example; it just wanted to get the risk behind it of losing a lawsuit that was shadowing its stock. Nor did its customers care; the salad-oil scandal hadn’t registered with them in the first place.

  Buffett wrote that two paths lay before the company, and that an American Express that took responsibility and paid the $60 million to the banks would be “worth very substantially more than American Express disclaiming responsibility for its subsidiary’s acts.”1 He described the $60 million payment as inconsequential in the long run, like a dividend check that got “lost in the mail.”

  Susie, who had thrown the dividend checks down the incinerator and had never had the nerve to tell her husband about the incident, might have been shocked to hear him so cavalierly dismiss a $60 million dividend check lost in the mail, had she known.2 And why should Buffett now be interested in whether American Express had “standards for financial integrity and responsibility…beyond those of the normal commercial enterprise”? From whence had come the notion that a reputation for integrity would translate into a business “worth substantially more”? Why did Warren want to testify? While he had always shared his father’s commitment to honesty, now he seemed to have inherited Howard’s penchant for pontificating on matters of principle.

  Buffett had always wanted to influence the managements of companies in which he invested. But in the past he had not attempted to turn his investments into a church, where he could preach while passing around the collection plate. Now he showed up at Howard Clark’s door unannounced to lobby him to remain resolute despite the shareholder lawsuit.

  “I had this habit of just sort of dropping in and talking to different people. There was one time that Howard said to me that it’d be a little nicer if I paid more attention to the organization chart…. He was very nice about it.”3

  As if to confirm Buffett’s sense that moral rectitude had financial value, American Express paid the settlement and worked through its travails, and the stock, which had plunged below $35, rose to more than $49 per share. By November 1964, the partnership owned more than $4.3 million of American Express stock. It had made other huge bets: $4.6 million in Texas Gulf Producing and another $3.5 million in Pure Oil, cigar butts both. Together the three made up more than half the portfolio.4 By 1965, American Express alone was almost one-third.

  The entire partnership had stood at only $7.2 million at the beginning of 1962. Buffett, fearless in concentrating his bets, would keep buying into 1966 until he had spent $13 million on American Express. He felt the partners ought to know a new “ground rule”: “We diversify substantially less than most investment operations. We might invest up to forty percent of our net worth in a single security under conditions coupling an extremely high probability that our facts and our reasoning are correct with a very low probability that anything could drastically change the underlying value of the investment.”5

  Warren had ventured far from the worldview of his mentor, Ben Graham. The hard-nosed “quantitative” approach espoused by Graham was the world of the speed handicapper, of the cigar-butt stooper who worked from pure statistics. Come to work in the morning, flip through the Moody’s Manual or the Standard & Poor’s weekly report, look for cheap stocks based on a handful of numbers, call Tom Knapp at Tweedy, Browne & Knapp and buy them, go home when the market closed, and sleep well at night. As Buffett said of this, his favorite approach, “The more sure money tends to be made on the obvious quantitative decisions.” But the method had a couple of drawbacks. The number of statistical bargains had shrunk to virtually nil, and since cigar butts tended to be small companies, it did not work when large sums of money were involved.

  While still working this approach, Buffett had had what he would later call a “high-probability insight” about American Express that confounded Ben Graham’s core idea. Unlike companies whose value came from cash, equipment, real estate, and other assets that could be calculated and if necessary liquidated, American Express had little more than its customers’ goodwill. He had bet his partners’ money—Alice’s inheritance; Doc Thompson’s savings; Anne Gottschaldt’s and Catherine Elberfeld’s money; the Angles’ life savings; and Estey Graham’s money—on that goodwill: the competitive advantage that Charlie Munger had been talking about when he spoke of the “great businesses.” This was the method of the class handicapper, of Phil Fisher, and it involved qualitative, as opposed to quantitative, assessments.

  Buffett would later write to the partners that buying “the right company (with the right prospects, inherent industry conditions, management, etc.)” means “the price will take care of itself…. This is what causes the cash register to really sing. However, it is an infrequent occurrence, as insights usually are, and of course, no insight is required on the quantitative side—the figures should hit you over the head with a baseball bat. So the really big money tends to be made by investors who are right on qualitative decisions.”6

  This new emphasis on a qualitative approach paid off in the stupendous results Buffett was able to announce to his partners at the end of 1965. When Buffett made his annual report to them, he compared the huge gain to an earlier prediction that he could beat the Dow by ten percent a year—and referred to the dazzling performance by saying, “Naturally no writer likes to be publicly humiliated by such a mistake. It is unlikely to
be repeated.”7 Despite the irony, he had begun a tradition of hedging against his partners’ high expectations. As his record of outstanding results lengthened, his letters also began to display a preoccupation with measuring success and failure. He used terms like “guilt,” “embarrass,” “disappoint,” or “blame” with unusual frequency, including to describe his so-called mistakes—for he remained obsessed with never letting anyone down.8 As readers began to recognize this pattern, some assumed he was manipulating them, while others accused him of false modesty. Hardly anybody knew how deep his sense of insecurity ran.

  In the year following Howard’s death, Warren began to think of memorializing him in some way—for example, through endowing a university chair. But he could never seem to find the perfect vehicle. He and Susie did set up the Buffett Foundation, which made small grants to educational causes. But this wasn’t what he had in mind for his father. And he had no intention of becoming a philanthropist; it was Susie who liked to dispense money and she who ran the foundation. Instead, Warren worked with no slacking of intensity. After his incredible home run on American Express, he hired John Harding from the Omaha National Bank trust department in April 1965, to handle administration. And yet, when Harding took the job, Buffett warned him: “I don’t know if I’ll necessarily be doing this forever, and if I quit, you’ll be out of a job.”9

  But there was no sign of his quitting. Harding had hoped to learn investing, but that ambition was soon destroyed. “Any idea that I wanted to handle investments on my own disappeared when I saw how good Warren was,” he says. Instead, Harding simply put most of his money into the partnership.

  Besides shoveling millions of dollars’ worth of American Express stock into BPL, Warren now chased bigger deals that required travel and coordination, both giant cigar butts and “qualitative” class handicapping deals that were a far cry from flipping through the Moody’s Manual in his bathrobe at home. His next target, another cigar butt, lay far from Omaha.

  Each of the Grahamites in Buffett’s network was always looking for ideas, and Dan Cowin had brought Buffett a textile maker in New Bedford, Massachusetts, that was selling at a discount to the value of its assets. 10 His idea was to buy it and liquidate it, to sell it off piecemeal, and to shut it down. Its name was Berkshire Hathaway. By the time the hair had grown back on Warren’s head from the shock of his father’s loss, he was in full pursuit of this new idea.

  Buffett began by circling over the company and observing it. He started leisurely accumulating stock in Berkshire Hathaway. This time, for better or worse, he had chosen a business run by a personality the size of Massachusetts.

  Seabury Stanton, president of Berkshire Hathaway, had reluctantly closed more than a dozen mills, one by one, over the past decade. The remnants sprawled along the rivers of the gently moldering towns of coastal New England like empty red-brick temples of a long-lost faith.

  He was the second Stanton to oversee the company, and was filled with a sense of destiny. Standing on New Bedford’s rocky shores, he cast himself as King Canute, telling the tides of devastation to retreat. But unlike Canute, he actually imagined they would obey. A New England version of American Gothic come to life, Seabury peered coldly down on visitors from his six-foot two-inch height—peered down if, that is, they managed to find him. He sat tucked away in a remote penthouse office at the top of a long, narrow staircase, protected by his secretary’s secretary, far from the din of the looms.

  New Bedford, the town that was his headquarters, once shone as the diamond in New England’s crown. For a while the ships that sailed from its harbor to hunt sperm whales made New Bedford North America’s richest city.11 Stanton’s grandfather, a whaling captain, had been head of one of the ruling families of the city, capital of the world’s most swashbuckling business. But in the mid-nineteenth century, as sperm whales grew scarce, the great harpoon ships had to venture ever farther north in search of the bowhead whale, all the way to the Arctic Ocean. In the autumn of 1871, the families of New Bedford waited in vain for their sons and husbands. Twenty-two ships, surprised by an early winter, lay trapped behind the Arctic ice and never returned.12 New Bedford would never be the same. Nor would the whaling business, once its mainstay, ever recover. As the supply of whales shrank, demand for their products had dwindled. After 1859, when oil gushed from the ground in Pennsylvania, kerosene became an increasingly popular substitute for the ever-scarcer whale oil. The flexible, comblike whale baleen13 used in women’s corsets, hoop skirts, and fancy parasols, in buggy whips and other mainstays of Victorian life, ceased to find a market as those products gradually disappeared from the shelves.

  In 1888, Horatio Hathaway, whose family had roots in the China tea trade,14 and Joseph Knowles, his treasurer, organized a group of partners to follow what they saw as the next business trend. They formed a pair of textile mills, Acushnet Mill Corporation and Hathaway Manufacturing Company.15 One of their partners was Hetty Green, the notorious “Witch of Wall Street,” a shipping heiress raised in New Bedford who rode the ferry to New York City from her tenement apartment in Hoboken to make loans and investments. She stalked through lower Manhattan in an ancient black alpaca gown, swirling cape, and rusty veiled hat like an elderly bat, her appearance so eccentric and her parsimony so notorious that rumors circulated that she wore newspapers as underclothes. By the time of her death in 1916, Green would be the richest woman in the world.16

  Financed by such investors, mill after mill sprang up to comb, spin, weave, and dye the deep stacks of cotton bales unloaded from Southern ships onto the wharves of New Bedford. Congressman William McKinley, chairman of the House Ways and Means Committee, who passed through the region from time to time to christen new mills, sponsored a tariff to protect the textile mills from foreign trade, for it was already cheaper to make fabric elsewhere.17 Thus, even from the beginning, the textile mills of the North needed political help to survive. Early in the twentieth century, a new technology—air-conditioning—revolutionized factories by allowing precise control of humidity as well as particulate matter in the air, and it was no longer economically justifiable to ship cotton out of the South, where labor was cheaper, to the chilly shores of New England. Knowles’s successor, James E. Stanton Jr., watched half his competitors’ mills melt away to the South.18 Put to the rack by repeated wage cuts, workers at the remaining northern mills went out on a crippling five-month strike that broke their employers’ backs. James Stanton “hesitated to spend stockholders’ money on new equipment when business was so bad and the prospects were so uncertain,” recalled his son.19 He pulled capital out of the business by paying dividends.

  By the time Stanton’s son Seabury, a Harvard graduate, took over in 1934, the aged, rickety Hathaway plant still rattled out a few bolts of cotton cloth each day. Seabury became seized with a vision of himself as the hero who saved the textile mills. He said “there was a place in New England for a textile company that had the latest machinery and capable management,” and he and his brother Otis conceived a five-year plan to modernize.20 They spent $10 million installing air-conditioning, electric lifts, overhead conveyers, better lighting, and futuristic locker rooms in the company’s venerable red-brick buildings. They shifted from cotton to rayon, the poor man’s silk, and made rayon parachute cloth during the war, enjoying a temporary boom. Nonetheless, as time passed, cheap foreign labor kept lowering the price their customers would pay. To compete, Seabury squeezed the pay of the workers in his modern new plant. But year by year the tides lapping at his shore—cheaper foreign fabric, better-automated competition, and lower labor costs in the South—presented a rising threat to his mills.

  In 1954, Hurricane Carol’s fourteen-foot storm surge poured into Hathaway’s Cove Street headquarters. Though the firm’s distinctive clock tower rode out the storm, a sea of muck and debris swamped the looms and yarn inside the building. Rather than rebuild the mill, the obvious response would have been to join the march southward. Instead, Seabury Stanton merged Hathaway
with another mill, Berkshire Fine Spinning, trying in effect to build a levee against a tidal wave.21

  Berkshire Fine Spinning made everything from the stiffest twills to the sheerest marquisettes, crisp curtain dimity, and fancy broadcloth shirting. Malcolm Chace, its master, steadfastly refused to sink a nickel into modernization. His nephew, Nicholas Brady, had written a paper on the business at the Harvard Business School in 1954, reaching so discouraging a conclusion that he sold his Berkshire stock.

  Chace naturally opposed Seabury Stanton’s demand for modernization, but the new Berkshire Hathaway was governed by Stanton’s sense of destiny. He simplified the product line, focusing on rayon, turning out more than half the men’s suit linings in the United States.22 As Berkshire Hathaway under Stanton unreeled nearly a quarter billion yards of fabrics a year, he continued his “relentless” modernizing, pouring another million dollars into the mills.

  By this time, his brother Otis had begun to have doubts about the feasibility of remaining in New Bedford, but Seabury thought the time for a textile mill to move south had passed,23 and refused to give up his dream of reviving the mills.24

  When Dan Cowin approached Buffett about Berkshire in 1962, Buffett was already aware of it, just as he was of any U.S. business of a meaningful size. The money that poured into the company meant that Berkshire was worth—according to its accountants—$22 million as a business, or $19.46 per share.25 And yet, after nine years of losses, anyone could acquire the stock for just seven and a half bucks. Buffett started buying it.26

  Seabury had been buying Berkshire’s stock as well, using extra cash that was not being poured back into the mills to make a tender offer for shares every couple of years. Buffett’s theory was that Seabury would continue, and he could time his own transactions, buying whenever the stock got cheap and selling it back to the company whenever the price rose.