The Snowball

by Alice Schroeder

  Even though Susie was the fountainhead of all this generosity, she was starting to need a little attention too. It wouldn’t have taken much, according to her friends, just an ounce of effort on her husband’s part. She disagreed that making money was life’s purpose. She felt impoverished denying herself travel, museums, theater, art, and most other forms of culture because of his lack of interest. Warren praised her effusively in public but when at home or work, lapsed into his normal preoccupied state. If he would make an effort by going to an art gallery with her now and then, or take her on a trip just because she wanted to go, it would make a difference, she said. But while he did sometimes show up when asked, if she had to ask, it was a favor, not a gift.

  Now that Susie realized that Warren was never going to take off to Italy for weeks on end, she began to travel on her own or with her women friends, sometimes to visit family—such as Bertie, who now lived in California—and sometimes to attend personal-growth seminars.

  One day at the Chicago airport, a man stopped in front of her as she sat on a bench. “Are you Susie Thompson?” he asked. She looked up, embarrassed to have been caught with a mouth full of hot dog. It was Milt Brown, her high school sweetheart, whom she had not seen in years. He sat down and they began to get reacquainted.20

  Susie, who was always reaching out for emotional connections, would later say that her husband wasn’t lacking in emotion, he was just cut off from his own feelings. And it certainly seemed as though his strongest emotional bonds were with his friends and partners, to whom he felt an intense obligation, and with whom he had created a de facto family. The other Buffetts could not help but notice the way he lit up in their company, in contrast to the dutiful but preoccupied manner he displayed while attending his own family events.

  Thus, even now that he was preparing to close the partnership that had consumed most of his waking hours for the last thirteen years, he remained fully engaged with his partners and seemed a little reluctant to let go of his connection to them. He went to extremes to help them place their money in good hands, writing them another letter describing their options in meticulous detail.

  Explaining his dedication to them, he says, “The question of finding other advisers is a tough one. When I wound up my partnership, I had these partners that had counted on me and I was going to be distributing a lot of money. I felt an obligation to at least suggest some alternatives for them.”

  This was unusual behavior for a money manager, to say the least. Even Ben Graham had only said, “Oh, buy AT&T,” when asked, and mentioned Buffett offhandedly to a few people. But Buffett made elaborate efforts to shepherd his partners on to their future investing life. Some of them were already in the Munger partnership, and Buffett sent one or two more to him. But Munger was queasy about the market. “Who wants to be around people when you’re disappointing them?” he says. “Particularly when you sucked them into the relationship?” He also lacked Buffett’s genius for promotion.

  “I recommended two people to the partners whom I knew were exceptionally good and exceptionally honest: Sandy Gottesman and Bill Ruane. I’d been around the investment world for a long time at that point, and I’d gotten to know them over the years. So I not only knew their results, but I knew how they’d accomplished their results, which was terribly important.”21

  So the richer partners would go to Gottesman at First Manhattan. But Sandy didn’t want the small-fry, so Buffett sent the rest to Ruane, who was now leaving Kidder, Peabody to set up his own investment advisory firm—Ruane, Cunniff & Stires—with two partners, Rick Cunniff and Sidney Stires, and creating the Sequoia Fund specifically to take on the smaller accounts. They hired John Harding, who would be out of a job when the partnership dissolved, to run an Omaha office for the new company. John Loomis, the securities salesman who was Carol Loomis’s husband, and Buffett’s trusty researcher Henry Brandt also went to Ruane, Cunniff—giving it in effect a full staff. These connections also kept Harding, Loomis, and Brandt in Buffett’s extended “family.”

  Buffett brought Ruane to Omaha and promoted the Sequoia Fund to the partners. He endorsed Ruane in typically mathematical terms. Unremarkably, even though he had known Ruane for years, he still felt it necessary to leave a small escape hatch, fearing blame in case things didn’t work out, and wrote: “There is no way to eliminate the possibility of error when judging humans…[but] I consider Bill to be an exceptionally high-probability decision on character and a high-probability one on investment performance.”22

  Yet while Buffett made arrangements to close the partnership, the first signs appeared that the market’s sparks were going to cool. By July 1969, when U.S. troops began withdrawing from Vietnam, the Dow had dropped nineteen percent. Even though the triumphant moon landing that summer gave the country a lift, Wall Street did not feel it. Exotic stocks like National Student Marketing and Minnie Pearl’s Chicken System, Inc.—which had garnered a huge following in a market where half the money managers and brokers had been working in the business for no more than seven years—were starting to collapse.23

  Blue Chip Stamps, the trading-stamp stock painstakingly accumulated by Buffett, Munger, and Guerin, now became a striking exception to the general trend. The three of them had been betting on whether the company could settle its antitrust lawsuit with Sperry & Hutchinson. When a settlement was reached, this stock—which the Buffett partners didn’t know they owned—showered nearly $7 million in profit on them in return for a $2 million investment less than a year ago.24 Now Blue Chip decided to have a public offering, and Buffett elected to sell the partnership’s shares as part of that deal.25 It seemed that the partners were going to have a splendid final year in 1969.

  That October, Buffett called another meeting of the Grahamites, including those who had gathered in San Diego the year before, sans Ben Graham himself. This time the wives were also invited, and although they did not join the meetings in which the men talked about stocks, their presence made the atmosphere more festive, like a vacation. Buffett delegated the planning to Marshall Weinberg, who lived in New York City and liked to travel. But Weinberg, who also liked to shave a dime and had no more experience of the jet-set life than Buffett, asked around and then made the unfortunate choice of the Colony Club, a Palm Beach, Florida, resort, where they were treated like rubes and snooted at even by the bellboys.

  Ruane reported at the first night’s dinner that the bellhop had handed him back his five-dollar tip with a sneer, saying, “You need it more than I do.” Bill Scott had given his bellhop a handful of the dimes he always carried in his pocket to make phone calls for Buffett. The bellhop threw the change all over the floor in the hallway on his way out.

  For the next five days, as the group enjoyed bad food, small rooms, high winds, and lashing rains, the men sat classroom style, with Buffett most often in his usual place at the front. They batted thoughts back and forth in an encoded shorthand derived from many years of conversation and a closely shared set of concepts and values.26 “Charlie told some horror stories,” Buffett wrote later, and “I drew the same gloomy conclusions, [while Walter Schloss] said that two mislocated steel companies with obsolete plants were still below book value so all was not lost.”27

  Buffett posed the Desert Island Challenge. If you were stranded on a desert island for ten years, he asked, in what stock would you invest? The trick was to find a company with the strongest franchise, one least subject to the corroding forces of competition and time: Munger’s idea of the great business. As Henry Brandt took copious notes on the various answers, Buffett delivered his own choice: Dow Jones, owner of the Wall Street Journal. His interest in newspapers was growing and would only become more intense, yet curiously he did not actually own this stock.

  The gathering ended much as it had begun, with more displays of rudeness from the hotel staff, who had no idea they were hosting anything other than a third-rate group of stockbrokers at a time when the market was falling.28 The staff had officiously shooed the Grahamites
away from the jewelry cases on the hotel mezzanine. On the last day, as the group was departing, Ed Anderson approached the front desk, and asked how best to get to the airport. Most of our guests go by limousine, he was told, but for you folks we’ll call a cab.29

  Buffett would go on to describe the Colony Club as “a friendly family hotel—that is, friendly if you were the Kennedy family.”30 It was a “low-class performance by a high-class place,” says Anderson. Later, when a Fort Lauderdale businessman who held the mortgage on the Colony Club asked Buffett to advise him on a financing deal, Buffett told the man he would be happy to do it without taking a fee, but “if you ever have a chance to foreclose on them, do it.”31

  One of those Buffett had invited to the Colony Club was Hochschild-Kohn’s Louis Kohn. Buffett had grown fond of Kohn and his wife, and he and Susie had vacationed with them in Cozumel. But inviting them to the Colony Club gathering proved awkward, since no sooner had the meeting been planned than Buffett and Munger started to realize that Hochschild-Kohn was not going to work out for them.

  “Retail is a very tough business,” says Charlie Munger. “We realized that we were wrong. Practically every great chain-store operation that has been around long enough eventually gets in trouble and is hard to fix. The dominant retailer in one twenty-year period is not necessarily the dominant retailer in the next.” Their experience had given them a deep wariness of retailing—one that would only grow, not lessen, over time.

  They wanted businesses that would marmalade them with money, businesses that had some sort of sustainable competitive advantage and could outwit the natural cycle of capital creation and destruction as long as possible. Not long after the meeting in Florida, Munger and Buffett sold Hochschild-Kohn to Supermarkets General for about what it had cost them.32 Buffett wanted to act fast in order to unload the company before winding down the partnership and distributing the assets. And along with the company, the Kohns disappeared from the Buffetts’ lives.33

  Diversified Retailing had issued unsecured debt (“debentures”) to finance the Hochschild-Kohn purchase. Buffett had taken special care with this, his first public financing, and insisted to his underwriters that the bonds have several unusual features. The bankers had objected that a novel structure would make the bond harder to sell.

  “I said, ‘Well, but bonds should have this in there.’ That was the first bond issue I ever sold, and I put a few things in there that the underwriters had no interest in whatsoever. But I had thought a lot about bond issues over the years. And I had thought about how bondholders got taken.”

  Bondholders historically earned less than stockholders because they gave up the potentially unlimited opportunity of a shareholder in favor of lower risk. But Buffett knew that in the real world this was not necessarily true.

  “One of the things I put in was that if we didn’t pay the interest on the bond for any reason, the bondholders took over voting control of the company, so they didn’t have to get Mickey Moused by bankruptcy and all that kind of stuff.” Ben Graham had written about this in Security Analysis, with as much passion as he mustered on any subject, describing how courts rarely allow bondholders to seize the assets that back those bonds unless the assets are nearly worthless. Unsecured bondholders’ interests were worked over in receivership through a strangling process that delayed payment almost to the point of irrelevance. Thus, DRC’s debenture also provided that the company could not pay dividends while the debentures were outstanding, meaning that equity investors could not siphon off profits while interest on the bonds was in arrears.

  The second unusual provision was that the debentures paid eight percent but, depending on the earnings of the company, could pay up to an additional one percent.

  And Buffett added a third provision. Because he felt that the bonds would be sold mainly to people who knew him or his reputation, he wanted the bonds to be redeemable if he sold enough stock in DRC that he was no longer the largest shareholder.34

  “And nobody had ever stuck anything like this in a covenant. I said, ‘You know, they’re entitled to have this in there. They may not want to redeem them, but they’re entitled if they want to. They lent money to me, basically.’” When his own banker, Nelson Wilder, protested that such clauses were unprecedented and unnecessary, Buffett overruled him.35

  Now that interest rates had risen, and banks were newly reluctant to lend, the debentures suddenly became a valuable form of cheap financing, a powerful consolation prize. Nevertheless, since Buffett thought of a dollar today as the fifty or hundred dollars that it could become someday, it was as if he had lost many millions on Hochschild-Kohn because of the forgone opportunity to use the money more effectively. He drew a conclusion that he would later state as:

  Time is the friend of the wonderful business, the enemy of the mediocre. You might think this principle is obvious, but I had to learn it the hard way…. After ending our corporate marriage to Hochschild-Kohn, I had memories like those of the husband in the country song ‘My Wife Ran Away with My Best Friend and I Still Miss Him a Lot.’…It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements. That leads right into a related lesson: Good jockeys will do well on good horses but not on broken-down nags.36

  Even as Buffett and Munger were working on the sale of Hochschild-Kohn in the fall of 1969, Forbes hit the newsstand with a story about Buffett titled “How Omaha Beats Wall Street.” The article opened in such an arresting manner that other writers covering Buffett would copy it for decades afterward.37

  “$10,000 invested in his Buffett Partnership in 1957,” Forbes said, “is now worth $260,000.” The partnership, which now had assets of $100 million, had grown at an annual compounded rate of thirty-one percent. Over that twelve-year period, “it hasn’t had one year in which it lost money…. Buffett has accomplished this through following consistently fundamental investing principles.” The anonymous columnist for Forbes then wrote one of the more insightful statements ever made about Buffett:

  “Buffett is not a simple person, but he has simple tastes.”

  This not-simple Buffett with simple tastes had insisted on total secrecy in his stock dealings when he ran his partnership, and was never once profiled in an interview. Now, however, when secrecy was no longer important, he had cooperated with a high-profile article about himself.

  The article did not print, or even whisper, his net worth. The reporter did not know that since Buffett closed the partnership to new partners in 1966, his fees, reinvested, had quadrupled his net worth to $26.5 million in just three years—nor that, with no money coming in from new partners to dilute him, his share of the partnership’s assets had risen from nineteen percent to twenty-six percent. The story cited his “rambling old Omaha house” 38 and the lack of computers and vast staff in his unimpressive office. True, the man with simple tastes still chugged four or five bottles of Pepsi a day, asked for it instead of wine at dinner parties, and ate only the dinner rolls if anything more complicated than a steak or hamburger was served. A helpless captive of whoever happened to be doing the laundry at home, he still sometimes turned up in public looking little better than a hobo and barely noticed the condition of his clothes. He would have been happy in a two-room garage apartment; the money was just his scorecard. It was Susie who cared about living well, and it was she who thought that money was pointless unless used for some purpose.

  Nonetheless, the Buffetts had for some time lived the life of a well-to-do couple—though not, of course, a life as luxurious as they could have afforded. Susie had even upgraded Warren to a Cadillac like her own, but only the most stripped-down version with no extra features, and after she had called every dealer within miles to get the cheapest deal. People found the contrast between his homespun tastes and his ever-growing fortune refreshing. His genial manner
, self-deprecating wit, and air of calm put them at ease. He had shed some of his earlier gracelessness and most of his arrogance along with the more obvious signs of insecurity—though his tolerance for criticism had not increased. He was learning to hide his impatience. He showed great loyalty to longtime friends. People were especially struck by his fundamental honesty.

  Those who spent long periods in his presence, however, found the unleashed whirlwind of his energy exhausting. “Insatiable,” they whispered, and sometimes felt a guilty relief when his attention lapsed. He inhaled information and was prone to deluging his friends with mountains of clippings and reading material that he thought would interest them, before realizing with a start that they had fallen months behind his pace. His conversations were less casual than they seemed. They always seemed to have a purpose, however obscure it might be to those on the receiving end. People sometimes realized he was somehow testing them. Buffett vibrated with an inner tension that belied his outwardly casual style.

  It was hard to imagine what he was going to do with all that energy and intensity without the partnership. Many of the partners found it hard to imagine what they were going to do without him. Many of them had become his trainbearers and were reluctant to let go. Their reluctance struck an ironic note next to the fate of the other Buffett family business. Concurrent with its centennial, Fred Buffett threw his hands in the air and gave up on the Buffett grocery store. Neither of his sons wanted to take over, and even though it had a half million dollars a year in sales, when he tried to find a buyer, there were no takers. The grinding wheel of capitalism had spoken.

  The Buffetts were not socialites and had never thrown a really large party. But with both the store and the partnership closing, they celebrated with a bash one night during the last weekend of September 1969. Nearly two hundred people of all ages and races poured into their house. Businessmen, society matrons, poor adopted “clients” of Susie’s, teenagers, friends who were now rich from the partnership, Susie’s women pals, assorted priests, rabbis, and ministers, and local politicians made their way through a string of flashing lights, past the three-foot Pepsi bottles in the windows. Susie had chosen a New York theme—Stage Door Deli food and decor—and told people to dress in “casual kosher.” They showed up in everything from culottes to cocktail dresses. A half-cut beer barrel burst with chrysanthemums in her favorite color, sunshine yellow. A table was set up like a deli cart, covered with pastrami sandwiches and cheeses and hung with sausages and a real plucked chicken, in keeping with the theme. A piano player next to the beer keg in the sunroom encouraged guests to sing along. The aroma from a popcorn machine outside the racquetball court welcomed guests into an impromptu basement movie theater. The court’s ceiling bobbed with giant helium balloons; films with W. C. Fields, Mae West, and Laurel and Hardy ran all evening long. In the solarium, the elderly Fred Buffett “protected” two bikiniclad models as the guests covered them with body paint.