The Snowball

by Alice Schroeder

  “And then my task,” says Peters, “was to go back into that little hermetically sealed Pasadena boardroom and tell all these buttoned-down gentlemen, including the management, that we’re not going forward with the Santa Barbara savings deal.” When she returned to the Spanish-style building, she was thinking about the plaza outside the boardroom windows with its tile-lined fountain. “If the windows had been open,” she says, “they would have thrown me out of them. I knew that what was going on in everyone’s mind was ‘My God, is this what happens when you let a hormonal woman on the board?’”21

  Wall Street thought so; it sent Wesco stock nosediving from a high of above $18 to $11 on the news. Wesco’s management was “old and not very aggressive,” one analyst said. Another claimed Santa Barbara was paying too much for Wesco, a “sleeping company for years, with old management.” Another referred to it as “garbage.”22

  For her courage, Buffett and Munger now felt indebted to Peters.23 They had also decided they wanted to own Wesco themselves and felt it would be possible to engage Vincenti and win his cooperation. However, by then it must have been apparent that Lou Vincenti would not gambol along behind them like a lamb after its mother. Accordingly, they loosened the purse strings and told their brokers, for once, to bid liberally on the stock. Blue Chip paid $17 for Wesco shares—the price at which they had traded before the deal fell through.

  “I will admit we were eccentric,” says Munger. “We deliberately paid more than we had to, but we felt we’d scuttled the damn merger and we didn’t like taking advantage of it by buying at the market price. We thought it was kind of the right thing to do. Well, nobody could understand that. They thought something must have been dishonorable about doing that. We really thought we’d make a better impression on Louie Vincenti if we didn’t scuttle the merger, then buy the stock cheap. That would look pretty God-knows-what, and we wanted Louie to be our partner for the long term. We were trying to behave well.”24

  By March 1973, Blue Chip owned a quarter of the Wesco stock. And Buffett, who had never stopped buying Blue Chip, continued his drive to get hold of more. The year before, he had exchanged Diversified’s Thriftimart shares for still more Blue Chip stock. Including the thirteen percent of Blue Chip he owned outright as well as his share of the stock owned by Berkshire and Diversified, which owned another thirty-five percent, Buffett was now effectively the largest Blue Chip shareholder. Blue Chip began to formally tender for Wesco’s shares, this time paying $15 a share in cash, until it owned more than half.25 Within weeks, Munger outlined for Lou Vincenti a vision for the company26 that, not surprisingly, resembled the way Buffett thought about Berkshire Hathaway and Diversified. Wesco, with Munger as chairman, would be another new doll among the rest27—this one residing inside Blue Chip.

  Then, no sooner had Blue Chip bought the majority of Wesco than the whole stock market fell apart.28 Buffett’s stake in the Washington Post lost a quarter of its value.29 Ordinarily he would have bought more. However, he had promised Graham that he wouldn’t. Instead, he recommended it to his friends.30

  So instead of buying more Post stock, Buffett—who had always believed in concentration—looked for new opportunities and began filling his basket faster than an Easter egg hunt with huge quantities of a handful of other stocks: National Presto, maker of pressure cookers and popcorn poppers,31 and a huge chunk of Vornado Realty Trust, which put him on its board.32

  Buffett had a set of legacy shareholders at Berkshire Hathaway who understood his investing approach and would never question his judgment. Thus he had earned the luxury of ignoring Mr. Market, which had marked down the value of his portfolio to a fire-sale price. Others were not so lucky. Bill Ruane’s Sequoia Fund was headed for a terrible year, and Ruane’s main financial backer, Bob Malott, was apparently unhappy. Malott knew Ruane from Harvard and they had shared an apartment when Ruane was working at Kidder, Peabody in New York. But Malott was sold on Buffett’s approach and track record; he asked for Buffett’s help with the pension fund of FMC Corporation, the company he now headed. So Buffett went to San Diego and spent several days interviewing investment managers and explaining his thinking to FMC’s investment people. In the process, he converted them to Grahamites with what would eventually become powerful results. At first he said no to the request of managing the portfolio himself—then eventually agreed to manage a portion.33 Along with his acceptance, however, he gave a warning: FMC would come last among his priorities, after Berkshire and Diversified, and Warren and Susie Buffett. The canny Malott jumped at the opportunity anyway, not mistaking the larger point: That Buffett was willing to do it at all meant that he would do it well.34

  Between his duties at FMC, Vornado, Blue Chip, and Wesco, and regular trips to New York, Buffett was now traveling much of the time. He was also busy courting Katharine Graham and had made such a good impression on her that she began to call him for advice. Susie made the rounds of Omaha, busy with the board of the Urban League, still giving out her scholarships, and taking on her latest crusade, the Future Central Committee, which was trying to save her alma mater, Central High School, from forced busing.35

  As 1973 progressed, even Hamilton the dog must have noticed the silence and emptiness descending on the Buffetts’ crazy, noisy home.36 Howie was two hundred and seventy-five miles away from Omaha at Augustana College. Susie Jr., unhappy with Lincoln, had transferred to the University of California, Irvine, where she was majoring in criminal justice.37 Peter, the child who had never required attention, was now a sophomore in high school. Thinking of moving to California, Susie had taken him to look at schools in Orange County. They stayed in Omaha, however, and now Peter spent much of his time in the basement, where Susie, who had gotten him interested in photography, had built him a darkroom.38

  Often now Susie stayed up late at night alone, listening to music that transported her to some different place.39 She loved the jazz guitar of Wes Montgomery and great soul music, like the Temptations, who sang of a world in which it was men who felt all the longing.40 She read books like I Know Why the Caged Bird Sings, Maya Angelou’s autobiographical account of overcoming the forces of racism, sexual abuse, and repression that made her early years a prison. “The idea of being confined in a place not of your choosing ran deep for her,” Peter says—not surprising after her childhood shut away in a sickroom, and growing up with a sister who was disciplined by being locked in a closet. Susie longed for romance, but now knew that she and Milt were never going to get married. Nevertheless, she could not bring herself to give up her connection to Milt.

  She was also spending more time with her tennis crowd of younger people at Dewey Park. One, John McCabe, a coach with a subdued personality, a sadness somewhat like her own, and a certain fragility, resembled most of her other lonelyhearts, but she seemed particularly drawn to him.41 Now that Susie had reasons to be away from the house most of the time, the hubbub began to dim, her hangers-on hung out with Susie elsewhere, and the rhythm of the house slowed from its all-day carnival atmosphere. Peter, never much attuned to his parents’ lives, noticed only the growing silence, not its cause. When he got home from school, he petted Hamilton, made something for himself for dinner, and headed downstairs to the darkroom.42

  Warren’s conception of his marriage had never changed, even though the marriage itself was changing inexorably. When he was home, Susie still seemed just as devoted to him as ever. He saw how active and busy she was and wanted her to be fulfilled, as long as she continued to take care of him—which he assumed was fulfilling to her. As far as he knew, the balancing act that had always worked for them still did.

  The “retired” Warren was investing at full throttle ahead in late 1973, in the midst of a market swoon. Between Cap Cities and the Washington Post and his growing friendship with Kay Graham, his interest in media over the past few years had permutated into a deep understanding of the subject at all levels. One night at dinner in Laguna Beach, he and Carol Loomis started strafing Buffett’s friend
Dick Holland, who worked in advertising, with questions about the advertising business. “Whenever he did that,” Holland recalls, “I always knew something was cooking.” The four of them talked business while Susie and Mary Holland, in purdah, entertained themselves. Sure enough, as a secondary way to play media, Buffett got on the phone to his trader and plunked down almost $3 million for the stocks of advertising agencies Interpublic, J. Walter Thompson, and Ogilvy & Mather, stocks so distressed he paid less than three times their earnings.

  While he was buying, however, most of the stocks that Buffett had accumulated were faltering. As 1974 began, stocks for which he had paid $50 million had lost a quarter of their value. Berkshire, too, started to slide, down to $64 per share. Some of the former partners who had kept the stock began to worry about whether they had made a mistake.

  Buffett saw it just the opposite way. He wanted to buy more Berkshire and Blue Chip. But “I’d run out of gas. I had used all the $16 million of cash I got out of the partnership to buy stock in Berkshire and Blue Chip. So all of a sudden I woke up one day and had no money at all. I was getting $50,000 a year salary from Berkshire Hathaway and some fees from FMC.43 But I had to start my personal net worth over again from zero.”

  He was now very, very rich but cash-poor. The companies he controlled, especially Berkshire Hathaway, had cash to buy stocks, however. To move some of Berkshire’s money to Diversified, Buffett set up a reinsurance company—a company that insures other insurers44—in Diversified. This company, Reinsurance Corp. of Nebraska, agreed to take part of National Indemnity’s business, receiving premiums and covering losses. Because National Indemnity was so profitable and generated so much “float”—premiums paid ahead of claims, i.e., cash—sending part of its business to Diversified was like sending a pipeline into a river of money. As time passed, it would give Diversified millions more dollars to invest.45

  Buffett began to buy stocks for Diversified. Principally he followed the Wattles model and bought stock in Blue Chip and Berkshire Hathaway. Soon, Diversified owned ten percent of Berkshire. It was almost as though Berkshire was buying back its own stock—but not quite. Diversified’s owners and Berkshire’s weren’t the same. Buffett still forbade his friends to buy Berkshire—whereas he, Munger, and Gottesman were partners in Diversified.46

  At the time, even though the three did each other business favors and swapped stock ideas on occasion, their interests didn’t necessarily align. Asked later under oath if he was Buffett’s “alter ego,” Munger said no. He acknowledged similar mannerisms and ways of speech. But “I’ve never chosen a role of being a junior partner,” he said. “I like the idea of having a sphere of activity” of my own.47 On one occasion, Munger said, he had found a block of Blue Chip stock that he and Gottesman wanted to buy for Diversified. Buffett wanted to take the block away from them and buy it for Berkshire Hathaway. After “a discussion”—clearly about who needed it more—the combined strength of Munger and Gottesman had somehow overpowered Buffett, and Diversified got the stock.48 At least that way they kept a little share.

  Still, Buffett did own forty-three percent of Diversified, so its purchases of Berkshire had added almost five percent to his personal ownership. Buying through Diversified was particularly attractive in that it tended not to ratchet up Berkshire’s stock price. Hardly anybody was paying attention.49

  But why did he want it at all?

  “Berkshire was not worth more than forty bucks as a business. You couldn’t have sold the textile mills and insurance business for more. And half the money was in a lousy business, I mean a really lousy business: twenty bucks a share of the forty bucks. And I didn’t know what I was going to do, I literally didn’t. I mean, I was rich enough already. But in effect, I was betting that I could do something. I was betting on myself. And though it sounds egotistical, anybody who might have thought it was worth more than forty bucks was purely paying for me. Because the company was not worth that.”

  He didn’t know what he was going to do, except invest. Verne McKenzie, who had returned from New Bedford to become Berkshire’s controller, thought that to Buffett, it simply “looked like an interesting game. All he was doing was solidifying his control.” That he was, and doing so in the manner in which he always approached investing—as a collector, one who bought in secrecy to avoid tipping off other bargain hunters. But as the chairman of Berkshire Hathaway and Diversified, he was once again mostly buying from sellers who had been his former partners. Although perfectly legal, it was not exactly sporting conduct. But their willingness to sell, in his mind, ended his special obligation to them.

  Buffett had also been buying Blue Chip Stamps all along, though so far, Blue Chip had remained primarily Munger’s province. It owned the best of the businesses, however, namely See’s. Now Buffett began to pursue Blue Chip stock like a great white shark after a well-fed seal. Since he had far greater financial resources, Buffett’s ownership percentage of Blue Chip quickly surpassed the combined interest of his partners in that stock, Munger and Rick Guerin—Munger’s associate from the Pacific Coast Stock Exchange, who now ran an investment partnership of his own.

  Buffett bought Blue Chip wherever he could get it. He bought from Blue Chip’s management and from other directors. One of these, Z. Wayne Griffin, asked $10.25 to Buffett’s bid of $10. Reaching an impasse on the phone, Buffett recalls that Griffin suggested they flip a coin. He was taken aback by Griffin’s willingness to do this, sight unseen. From that fact alone, Buffett realized not only that Griffin trusted him, but that he had already Buffetted himself. Griffin called it heads. Obviously, if he made such a bet, he was willing to take the ten bucks, which he did.

  Buffett’s accumulation of all these stocks, however, differed from his buying in the era of cheap cigar butts. Two large question marks hung over Blue Chip, Diversified, and Berkshire. As Buffett solidified control, all that money pouring in to both Berkshire and Diversified from the insurance business would have to be put to good use. And the bet on Blue Chip’s legal problems would have to work out.

  By year-end 1973, Blue Chip had settled eleven lawsuits.50 All that remained was the Justice Department’s ruling that it divest one-third of its business. That would not be easy because “the President’s freeze on food prices is another knee in the groin for us,” Don Koeppel wrote. “The grocers are screaming, predicting huge losses, bankruptcy in some cases.”51 Inflation had run rampant, President Nixon had frozen prices on commodities to try to halt it, and commerce had entered a new era of trying to match rising costs to frozen consumer prices.

  The stamp business was dead, but Buffett, the implacable acquirer, had his stock. After this series of trading gyrations, Blue Chip had Wattled its way into the set of Russian dolls. “It was the same principle,” Buffett says. Including all the pockets in which he had bought shares indirectly, he owned more than forty percent of Berkshire and more than twenty-five percent of Blue Chip Stamps. Even though these stocks traded at depressed prices, he could fund more deals and buy more stocks because all of the dolls had their own self-charging batteries, “float,” cash that could be invested in advance of paying claims. This innovation dramatically improved the deal.

  The operating businesses themselves had also improved since the dismal days of windmills and fire maps. Along with See’s, Berkshire owned not only the whopping float-generator National Indemnity but also a clutch of little insurance companies that Buffett hoped would eventually turn into small power-houses, even though he was struggling to whip them into shape. Meanwhile, the deadweight of Hochschild-Kohn had disappeared and Buffett kept shrinking the textile mills.

  But in the bigger picture, what Berkshire, Diversified, and Blue Chip really possessed were two things. The first was the homeostatic business model—the idea of grafting float onto a holding company so that it could respond internally to the changing environment. The second was the power of compounding, as float and investments doubled and redoubled over time.

  The novelty and s
trength of Buffett’s model cannot be overstated. Nothing else like it existed, or would for years to come. “That was the golden period of textbook capital allocation,” he says.

  The timing was stupendous. Capital from the insurance companies was pouring into Berkshire and DRC at the same time that the market was collapsing, the environment that Buffett liked best. While he had not yet decided exactly what to do with the collective enterprise he had built by the end of 1974, of two things he was certain. One was the business model’s power, and the other his skill in using it. Above all, he had confidence in himself.

  “Always,” he says. “Always.”

  39

  The Giant

  Omaha and Los Angeles • 1973–1976

  Howard Buffett was one of those rare people who prospered in the aftermath of the 1929 stock market crash. Now his son’s star was rising during the second great crash of the century.1 But the world had changed; stardom, even in business, now meant fame. Buffett had closed his partnership during a media explosion in the United States in which cable had transformed television, newspaper companies were going public, and advertising was still in a golden age of selling to a monolithic audience in which virtually the whole nation sat down together on Tuesday nights and watched Happy Days.

  Buffett had entered the media world as an investor drawn to the business by a natural affinity. But as he embarked on a new, post-partnership phase of life, through the publicity he got from the Forbes story in 1969 and then from the Supermoney profile, he began to enjoy the fruit of the discreet use of profile-raising press. Now he was a subject of media interest, not just a media investor; and no less a personage than Katharine Graham was paying him attention and taking him seriously, which had brought him into the orbit of one of the most important newspapers in the United States.