The Snowball

by Alice Schroeder

  “It was kind of like an elaborate minuet or something. Sunnylands was designed to be sort of a court for Walter. You had two people living there and fifty-something servants. You had a billion dollars’ worth of art on the walls, and I’m the only guy that was ever there that didn’t ooh and aah over the art. I’d just as soon have a bunch of old Playboy covers on the walls.” (Susie, however, might not have enjoyed herself quite as much.)

  “They put us in the Blue Room. The bedspreads, the covers on the books were all blue. Everything was blue. The jelly beans were blue. Every guest room had two maids, so they could serve us breakfast in bed at the same time, and the trays would be placed down at the exact same time and they would lift the covers at the exact same time.

  “When we would walk out in the evening dressed for dinner, there would be one maid on each side of the door. And Susie’s maid would say, ‘Madame looks beautiful tonight.’ And then my maid would look at me and just sort of gurgle. She’d had a week to prepare for me and think of what to say, and she can’t come up with anything.

  “Walter had his own private nine-hole golf course at Sunnylands. He had his own driving range with ten tees lined up and all these golf balls piled in perfect little neat pyramids. And there wasn’t anybody there. The course was immaculate. If he had four foursomes, Walter would say, ‘That’s too much play for my course,’ and send one of them off to play at Thunderbird Country Club. I’d go out there and hit four golf balls, and somebody’d run out and replace the pyramids. And that was the day at Sunnylands. It was as fancy as living gets.”

  Buffett, of course, had his own views about pyramids and pharaohs, but he liked Annenberg and was happy to play golf with him. Though he would never spend his money that way, Buffett believed that people had the right to spend their own money any way they chose. Besides, he would never dream of criticizing the ambassador. Annenberg paired Buffett that weekend with Reagan as a golf partner, so Secret Service agents trailed them—but refused to fetch golf balls out of water traps as Buffett had hoped.

  Buffett had a mixed view of Reagan as President. He admired Reagan’s handling of geopolitics. However, under Reagan the United States went from being the world’s largest lender to its largest borrower. Just as junk bonds and leverage were ballooning on Wall Street, the government had been running up mountains of debt—which Buffett considered the Wimpy style of economics: I will gladly pay you Tuesday for a hamburger today.60 Buffett’s style was to own the cattle ranch—and he had the balance sheet to prove it.

  Armored by Berkshire Hathaway’s balance sheet—and a golf scorecard signed by the President of the United States—Buffett was now a fortress of power, a fount of widely acclaimed wisdom. After his role rescuing Scott Fetzer, people thought of him as a high-profile protector. Every financial statistic pertaining to him and his company rang with exclamation points. Berkshire Hathaway’s book value per share had grown by more than twenty-three percent a year for twenty-three years! Buffett’s first group of partners had reaped $1.1 million for each $1,000 put into the partnership! Berkshire was trading at the dizzying price of $2,950 per share! Buffett himself had a net worth of $2.1 billion! A Wall Street money manager—an investor—was the ninth-richest man in the U.S.! Never in history had anyone climbed from the ranks of those who managed other people’s wealth to join the celebrated few on top of the feeding chain of riches. For the first time, the money from a partnership of investors had been used to grow an enormous business enterprise through a chess-game series of decisions to buy whole businesses as well as stocks. Inevitably, more people were going to call him for help.

  The next person to pick up the phone was John Gutfreund, the man who ran Salomon Brothers and had endeared himself to Buffett by helping to save GEICO in 1976.

  That he had done so showed both the strength and weakness of Salomon. The GEICO stock underwriting had been based on the opinion of one equity research analyst. If the firm had any stature in the marketplace of selling stocks, it would have passed on the deal as far too small to be worth the legal liability if it failed—as all the other firms had done. But Salomon, bold and decisive rather than bureaucratic, dared the risk because it needed the business. Buffett had always taken a liking to people who extended themselves and helped him make money. And Gutfreund’s reserved, intellectual prep-school personality, coupled with a domineering brutality, seems to have added to Buffett’s trust in him as overseer of an unruly-by-nature investment bank.

  Gutfreund had grown up the son of a well-to-do meat-truck company owner in Scarsdale, New York, a golf-course-ringed suburb of commuters close to New York City. He’d majored in literature at Oberlin College and considered teaching English, but was drawn to the trading floor by a golfing friend of his father’s, Billy Salomon, a descendant of one of the firm’s three founding brothers.

  Salomon Brothers was born in 1910 when Arthur, Herbert, and Percy Salomon, carrying $5,000 of capital, knocked on Wall Street’s doors to broker short-term loans. Less than a decade later, the U.S. government became the tiny firm’s client by adding Salomon to its list of registered dealers of government securities. With this endorsement, Salomon, a game little terrier, scrapped its way to respectable size over the next three decades by sticking to its core business of trading bonds using its wits, nerve, and fidelity to clients.61 Meanwhile, dozens of other small brokers closed shop or were swallowed up by larger ones.

  Billy Salomon had installed Gutfreund as a trading assistant. Joining a roomful of men who spent their days buying and selling bonds for clients on the phone, Gutfreund, like the rest, carved off a little slice of everything for Salomon in return for his labors. He proved a deft trader and made partner in 1963 at the age of thirty-four. Partners at Salomon were bound by the edict of Billy Salomon, all of their interests welded together by the capital he forced them to leave at risk in the firm—instead of taking it out year by year as bonuses and profits.

  In 1978 Billy Salomon promoted Gutfreund to head of the firm, then retired. Three years later, Gutfreund showed up on his friend and mentor’s beachfront porch in East Hampton to say that he was selling Salomon to Phibro, a giant commodities dealer, to create Phibro-Salomon Inc. Gutfreund and his partners walked away with an average of nearly $8 million apiece in profit from the sale, while those who had built the firm and were now retired—like Billy Salomon—got zero, zilch.62 One former partner thought it a Greek tragedy: the story of Oedipus, who had killed his own father.

  Gutfreund became co-CEO with Phibro’s David Tendler. Running a firm with a co-CEO is like trying to balance two ends of a seesaw in the air. When Phibro’s business slumped after the sale just as Salomon’s was soaring, Gutfreund wasted no time. He slammed his end of the seesaw to the ground and sent Tendler flying.

  After Gutfreund took control, he added a foreign-currency business, broadened into equity trading and underwriting, and expanded the bond business into Japan, Switzerland, and Germany. For the next few years, the witch doctors from academia with their computers and formulas filtered onto Wall Street, and Phibro-Salomon’s floor became populated with PhDs who unlocked the mathematical secrets of stripping, slicing, packaging, and trading mortgages and other bonds. By inventing a whole new segment of the bond market, Salomon (for the Phibro-Salomon name never quite replaced “Solly” in people’s minds and was dumped in 1986) grew in a few short years from a second-tier firm to the top of the Street, with a swagger to match, as its traders stayed many steps ahead of other banks.

  They ruled from “The Room,” Solly’s trading floor, a smoky palace about a third the size of an airplane hangar, filled with long double rows of desks where the traders, salespeople, and assistants crouched in front of banks of screens with a slice of pizza in one hand and a telephone receiver in the other. The daily battle took place as a symphony of groans and curses and farts and screams punctuating the background babble, yelps, and mutterings of trader talk. Eccentrics were welcome, as long as they produced. Gutfreund shot down the aisles every m
orning from his desk on the floor as if fired from a cannon. He glared through horn-rimmed spectacles, chomping his stogie, and shredded screwups into piles of mulch on the trading floor.

  The characters on the trading floor bartered with a camaraderie born of competition and a united obsession with killing the other team. They so dominated the bond-underwriting market that BusinessWeek crowned Salomon “The King of Wall Street.”63 The story also said it was the kind of place where the “long knives” could come out if things went south—in other words, that Gutfreund would purge anyone suspected of dissent in order to still a revolt.64

  Salomon’s profits peaked in 1985, when the firm made $557 million after tax. But the new businesses—principally equities—didn’t earn their keep; thus, internal competition started to get out of hand. The traders who had built Salomon’s unique and profitable business started to leave, enticed by million-dollar offers from other firms. Soon they populated Salomon’s competitors. Gutfreund ratcheted the pay upward to stem the tide. But he did not crack down on departments like equity trading and investment banking when they failed to produce, then came in with new five-year plans to fix their failures. His intimidating personality covered a soft underbelly: He shrank from hard decisions and substantive confrontations. As time passed, he spent less time in The Room and presided with a somewhat distracted air over a kingdom in which the threat of poison hung in the air. “My problem is that I am too deliberate on people issues,”65 he would later say. Somewhat unfairly, observers blamed not him but his wife, Susan.

  Tied to her husband by a long, long leash, all through the 1980s Susan Gutfreund had raced headlong up Fifth Avenue, dragging the once-retiring, silver-haired CEO of Salomon behind her into international society. Gutfreund came to tolerate and even enjoy it because, he said, she expanded his horizons. With Susan blowing with the force of a nor’easter, he turned his rudder and ran into the wind. Modesty and thrift were the first to go overboard.

  “It’s so expensive to be rich,” the former flight attendant complained—perhaps facetiously but nonetheless famously—to Malcolm Forbes.66 Susan’s party guests received chauffeur-delivered invitations tied with yellow roses for events that featured four types of caviar. She chilled her perfume in a refrigerator next to her bathtub. She yanked up her Chicago roots to become such a Francophile that her butler answered the phone in French. She greeted First Lady Nancy Reagan, at their first meeting, “Bonsoir, Madame.” At the couple’s River House living room in New York City, millions of dollars’ worth of French antiques sat atop a million-dollar rug. She redid Salomon’s executive meeting room, drenching it with so much passementerie and ormolu that it “looked like a French bordello.”67 She wore the collection of designer Hubert de Givenchy, who lived across the courtyard from the Gutfreunds’ eighteenth-century Paris pied-à-terre. In New York, their righteously indignant neighbors sued them when an allegedly unauthorized crane appeared on their penthouse terrace to hoist a twenty-two-foot, five-hundred-pound Christmas tree into the Gutfreunds’ living room.68 Thus did Susan Gutfreund become 1980s Nouvelle Society’s most beloved object of parody. The Gutfreunds graced magazine covers and Susan earned a role in Tom Wolfe’s roman à clef, The Bonfire of the Vanities.69 Susan’s friends defended her, but however overdone the satire might be, nobody, not even her husband, questioned that this outpouring of opulence had diverted his attention, at least a little bit.70

  A corporate history published around this time included a telling remark. Instead of making a decision and expecting others to follow, it said Gutfreund “liked to involve the people who would be affected” and “would bend over backward to make them comfortable with what was to be done.” Nevertheless, wrote the author, protesting a bit too heartily, Gutfreund “is in ultimate control” and “his decisions after consultations are final.”71 In fact, some of Gutfreund’s former partners, now retitled “managing directors,” were mounting a major challenge to his authority. Having kept their commitment to grow, they now blamed him for the bloated costs and vied with one another for territory.

  By the end of 1986, when earnings had begun to sink from the burden of the newly swollen payroll—Salomon had increased its staff by forty percent that year—the managing directors nearly dethroned Gutfreund in a coup. The firm’s largest shareholder, the South African company Minorco, grew impatient and told Gutfreund it wanted to sell its block of stock. But when “nothing happened,” according to several of the managing directors, and Salomon’s stock languished as the Dow rose forty-four percent, Minorco found its own buyer: Ron Perelman, the feared corporate raider who had taken over Revlon.

  The executive team did not want to work for Perelman and whomever he brought in at the top.72 Gutfreund pushed the panic button and called Buffett, asking him to invest in Salomon as “white knight” to save Salomon from Perelman—much as Buffett had saved Ralph Schey at Scott Fetzer from Boesky.73

  Owning a company that sold vacuum cleaners was one thing. Even though Salomon was dominated by trading, which Buffett liked, the firm was muscling its way into investment banking and had recently caved to market pressure and set up a merchant banking business to finance takeovers using junk bonds, a technique he despised. The firm was late to the highly competitive merger business, still a novice.74 In trying to launch Salomon in these rough waters, Gutfreund seemed uncomfortable; he had aged visibly in just one year.75

  Yet Salomon’s expertise in reshaping the bond market appealed to Buffett at a time when good stock ideas had become scarce.76 While he denigrated junk bonds, he didn’t shun the takeovers that were done using them. In fact, he opportunistically arbitraged those deals—shorting the stock of the acquirer and buying the stock of the acquiree. Since Salomon’s bond arbitrage unit made most of the firm’s profits, the firm in fact was an arbitrage machine, and he had a deep affinity and respect for this corner of Wall Street.

  Moreover, Buffett’s nostrils had caught the rich warm scent of money, for Gutfreund had the air of desperation. So he said that Berkshire would buy $700 million of Salomon preferred stock, as long as it made fifteen percent.77 Gutfreund ordered his horrified employees to design a security that would deliver to Buffett the kind of returns normally earned only on a junk bond. Over the weekend of Rosh Hashanah, the Jewish New Year, when Gutfreund knew the observant Perelman would be neutralized, Buffett flew to New York, and he and Gutfreund met at Salomon’s lawyers’ offices. Buffett walked in by himself, without a briefcase or even a pad of paper in his hand. Over a handshake, he agreed to buy a preferred stock with a nine percent coupon that would convert to common stock at the price of $38.78

  The nine percent yield gave Buffett a premium return until the stock went to $38, when he had the right to convert to equity. So the upside was unlimited. But if the stock went down, he had the right to “put” the security back to Salomon and get his money back.79 The deal worked out to an expected fifteen percent profit, on an investment that carried very little risk.80

  The annual dividends on this preferred stock—$63 million—were more than Blue Chip and Berkshire had spent on the Buffalo Evening News and See’s Candies together. Inside Salomon, people were outraged.81 They felt that Gutfreund had dithered on the Minorco request, then called Buffett in desperation, and had to overprice the convertible as a result. And thus, for his huge fifteen percent return, Buffett was, as writer Michael Lewis would later explain, making “only the safe bet that Salomon would not go bankrupt.”82

  What the firm had bought with all this money was Buffett’s reputation, which came partly at the expense of Gutfreund’s power. Along with the deal, Buffett and Munger each got board seats. Before signing the papers, Buffett climbed aboard his new jet and flew to New York. He met Munger at One New York Plaza to inspect Salomon.

  Standing outside Gutfreund’s office next to the trading floor, he beheld The Room for the first time. Hundreds of disheveled people sweated in front of tiny green screens. Most had phones glued to each ear as they jostled, spat, puffed, and
spun their way through multimillion-dollar deals. Curses and screams cut through the low roar that filled the air. Above the scene hung a hazy fog. So many traders calmed their nerves with tobacco, why bother to abstain? Everyone’s lungs were always filled with nicotine anyway.

  Munger crossed his arms and turned to Buffett. “So, Warren,” he said. “You really want to invest in this, huh?”

  Buffett stood, gazing out through the haze over the pandemonium that he was about to buy. “Mmmm-hmmmm,” he said, after a long pause.83

  47

  White Nights

  New York City • 1987–1991

  Observers stood slack-jawed that the Midas from Omaha had gilded the mighty Salomon Brothers with his touch. Buffett—the burger-chomping billionaire next door, who drove an eight-year-old Cadillac, lived in his original $31,500 house, and possessed few of the tokens of the rich and famous—owned a major investment in a Wall Street bank.

  He routinely railed against the Wall Street of which he was now very much a part. He wrote the Berkshire shareholders excoriating the junk bonds used to finance takeovers—including Salomon’s—which, he said, were “sold by those who didn’t care to those who didn’t think.”1 “I never talk to brokers or analysts,” he said. “You have to think about things yourself…. Wall Street is the only place people ride to in a Rolls-Royce to get advice from people who take the subway.”2 On the pages of the Washington Post, he had decried the “casino society” that was making the corporate raiders rich. Why not tax one hundred percent of the speculators’ profits?3 There was certainly a lot to tax. From 1982 to 1987, the Dow Jones Industrial Average had streaked from 777 to 2,722. If you want to make money, he told business-school students, “hold your nose and go to Wall Street.” But he was already there.