The Snowball

by Alice Schroeder

  Meanwhile, the high cost of 1987 was not quite over. A belated note from Katharine Graham to members of the Buffett Group arrived two weeks before the end of the year. Some of them went into shock. She had sent them a bill. As it turned out, they had not been her guests. Instead, they themselves had been paying for the extravaganza in Williamsburg that Kay had put on! The total was “somewhat breathtaking,” she acknowledged, adding, “I’m really sorry it’s so late and so much. I hope Xmas is still merry and I’m still your friend.”24

  Buffett did have a merry Christmas, but for another reason: His present to himself was Coca-Cola. It would make up for a great deal of the unhappiness from Salomon. At a White House dinner some time earlier, he had reconnected with his old friend Don Keough, who was now president and chief operating officer of the company; Keough had convinced him to switch from his own concoction of Pepsi dosed with cherry syrup to the newly introduced Cherry Coke. Buffett tried it and liked it. His family and friends were gobsmacked when the man so famously loyal, especially to Pepsi, performed this turnaround. For years, however, KO stock had been too expensive for Buffett to consider. Now, however, the company had gotten into trouble, its bottlers locked in a fierce price war with Pepsi that had taken the price of Coke down to around $38 a share. Rumor said that it had become a takeover target of the dreaded Perelman, and the company was buying back its own stock. Although still expensive, it had the same quality of a great brand under duress as American Express had had earlier.

  The way Warren looked at it, Coca-Cola was no cigar butt, yet it was pouring forth a waterfall of cash, and spending only a small portion of that to operate. Its cash flow each year had value; that was something he could quantify in his head. Since he had studied the company for years, he knew how much money it had made in the past and he could make a sensible judgment of how much Coca-Cola’s businesses were going to grow for many years in the future.25 Adding up those estimates of cash flow year after year gave him an ultimate value.

  Predicting the company’s prospects many years from now wasn’t a precise science, however. Buffett applied a margin of safety to his estimates. He did this simply by taking a whack at the number, rather than using some complicated model or formula. He used no computers or spreadsheets in doing any of these calculations; if the answer didn’t hit him over the head like a caveman’s club, in his view, the investment wasn’t worth making.

  After the estimate came the decision. He had to compare what Coca-Cola would ultimately be worth as a business—the bird in the bush—to the bird in the hand, which was Berkshire’s cash. Simply by investing the cash in government bonds that had no risk of losing money, Berkshire could earn a certain amount over that same period. He compared the two. By that yardstick, Coca-Cola was a beauty, and in fact, there wasn’t any other stock he knew of that stacked up better. Buffett started buying it.

  When Coca-Cola products turned up at Buffett’s shareholder meeting in 1988, Berkshire shareholders began swigging Coke in imitation of him. They had no idea that, through Berkshire, they also owned the stock. The meeting took on a whole new tenor that year when a thousand people showed up at the Joslyn Art Museum auditorium. This was the year that the Frozen Corporation, no longer a quasi-partnership, officially joined big-time corporate America and listed itself on the New York Stock Exchange. The Berkshire meeting had to be delayed because so many people showed up that shareholders were having trouble finding parking spots. Buffett had an inspiration. He rented two school buses and persuaded a few hundred shareholders to follow him after the meeting, like the Pied Piper of commerce, to the Nebraska Furniture Mart. Part of the appeal was the chance to meet the indomitable Mrs. B, about whom Buffett had been writing and talking for five years. The shareholders were so charmed by the tiny tank of a woman perched on her electric cart in the carpet department—and by her prices—that they spent $57,000.26

  By year’s end, the shareholders still did not know that Berkshire had purchased more than fourteen million shares of KO at a cost of almost $600 million.27 Because his every action now moved markets, Buffett had gotten special dispensation from the SEC not to disclose his trades for a year. He was buying so much KO stock and the company itself was repurchasing so much that, rather than compete against each other and bid up the price, “they would buy half and Buffett would buy half” of the daily trading volume, according to Walter Schloss.28 Berkshire soon owned more than six percent of the company, worth $1.2 billion.29 In March 1989, when his position was revealed, the resulting hullaballoo caused so much demand that the New York Stock Exchange had to stop trading the stock to keep the price from skyrocketing out of control.

  Coca-Cola’s CEO, Roberto Goizueta, had glowed with delight at the famous investor’s endorsement. He asked Buffett to join his board, possibly the most prestigious in North America. Buffett had accepted with alacrity, steeped himself in all things Coca-Cola, and met a number of new people who were fellow board members, including Herbert Allen, the blunt-spoken, straight-shooting chairman of Allen & Co. The two became allies. Allen invited the Buffetts to his Sun Valley conference, which was emerging as the quintessential elephant-bump for corporate CEOs. At Sun Valley, investors, Hollywood, and media moguls met to mingle and play every July.

  Buffett knew this meant adding a new annual event to his calendar, but Sun Valley was important and he wanted to attend. Moreover, he now had the means to arrive in style. In keeping with his rising stature as a member of the CEO Club, he had just swapped the used Falcon for a fancy new Challenger jet that cost nearly $7 million. He revealed the airplane—which he had dubbed the Indefensible— in his shareholder letter, making sport of himself with St. Augustine’s prayer: “Help me, oh Lord, to become chaste—but not yet.” He would soon write his shareholders that he wanted to be buried in the jet.

  On his way to the airport to fly to Sun Valley, Buffett visited his sister-in-law Dottie in the hospital. Frail, twig-thin, a longtime alcoholic, Susie’s sister had contracted a severe case of Guillain-Barré syndrome, an autoimmune disorder of unknown origin and sudden onset that can cause almost total paralysis of the nervous system, including the respiratory system and other organs. Dottie was in a coma. She was so debilitated that her doctors recommended discontinuing treatment and letting nature take its course.

  Susie, distraught, refused to allow this. She remained in Omaha throughout the summer and fall to nurse Dottie, who underwent a slow and arduous process of extensive care and physical therapy. Since Susie was in Omaha for an extended stay, she had taken an apartment in Dottie’s building, across the hall from her sister. While there, she helped Howie campaign for Douglas County commissioner, an office that governed Omaha and its environs. He was running as a pro-choice Republican, in a race where being Republican helped and being pro-choice didn’t hurt. Buffett had chosen not to back his son financially, once again confounding the perception that a rich man’s son had plenty of cash, so Howie had to raise his own funds. But Susie stuffed envelopes and attended fund-raisers, covering herself with campaign buttons and showing her break-front smile everywhere, in order to put the family imprimatur behind her son. Her presence made everything easier.30 When Howie won the race, Buffett was exceptionally pleased. Farming had never resonated with him; politics made his heart race. He felt that Howie was starting to mature and detected the stirrings of ambition in his son. The Buffetts began to talk of Howie’s running for Howard’s old seat in the second Congressional district.

  While Peter remained in San Francisco, two of Buffett’s three children were now nearby—the two who had always wanted his attention the most. Susie Jr. had recently moved back to Omaha following the birth of her second child, Michael, after mentioning to her father—without telling her husband—that Allen wanted to run the Buffett Foundation, which needed professional management after undergoing a strategic reorganization under the direction of family friend and activist Shirley Smith. Warren seized this chance by the throat. It not only brought his daughter home but also l
ooped Big Susie closer to him.

  Having his daughter around pleased Warren in another way. Susie Jr. shared her mother’s caretaking quality, although packaged in a more businesslike style. He would now have two women in Omaha to look after him. More women to look after him was something that he had always rationalized. “Women don’t mind taking care of themselves,” he said. “Men mind taking care of themselves. I think women understand men better than men understand women. I’ll eat asparagus before I give up women.” His desire to be taken care of by women was so overwhelming that he mostly left it up to the women to settle any differences in their hell-bent desire to do what, in each of their opinions, was in his best interest. Susie Jr. and Astrid began to work out their respective roles.

  The network of connections he had forged now brought Buffett a business that would certainly put him in favor with all his women—Borsheim’s, an Omaha jewelry store. Louis Friedman, the brother-in-law of Mrs. B, had founded this company, which carried high-and mid-range merchandise at discount prices. Buffett had learned how strongly women preferred jewelry to clothes, no matter how well clothing “held its value.” The person most likely to be pleased by this purchase was Big Susie, who had been assembling an impressive collection of jewelry given by her contrite husband. Susie Jr. also appreciated jewelry, as did Warren’s sisters and Kay Graham. The only one not that interested in jewelry was Astrid, who was uncomfortable with expensive things, though if he gave her jewelry, she certainly wouldn’t turn it down.

  So Warren’s Christmas shopping for the women in his life was simplified in 1989. He worked out a system: earrings, pearls, watches, everybody would get a variation on some theme each year. But he himself got nothing to equal the hefty chunk of Coca-Cola that he’d bought so happily the year before. Worse still, he got a lump of coal in his stocking in the form of a new book, Liar’s Poker, written by former Salomon bond salesman Michael Lewis. Named after a bluffing game that traders played using the serial numbers on dollar bills, the book captured Salomon’s swaggering, innovative, energetic culture and how it had begun to break down in 1986 and 1987. Liar’s Poker turned into a whopping bestseller; it depicted the firm’s eccentricities so memorably that Salomon would never again live down its reputation as a sort of zoo for the most aggressive and uncouth people on Wall Street.31 The end of the 1980s takeover boom was another problem for Buffett, for while he was still arbitraging announced deals, his usual feeding territory was empty. With no great businesses to buy, Buffett once again lowered his standards as he had when buying Hochschild-Kohn.

  The lure this time was other CEOs, who, fearing for their jobs or their autonomy, began to offer him more special deals to invest. For Berkshire, he bought three apparently lucrative “convertible preferred” stocks, all structured along the lines of the Salomon deal, paying him on average nine percent, which gave him a floor on his return while also giving him the right to convert in case the companies did well. Each of these companies was quite different. Champion, a poorly managed paper business, was thought to be “in play” among takeover artists.32 Gillette, a business with a huge “moat” around its brand—like See’s Candies, invulnerable to competition—was being temporarily shunned by investors. And Pittsburgh-based US Air, formerly called Allegheny Airlines, a weak regional player in a newly deregulated industry, was also “in play.”

  Like the Salomon preferred stock, the terms of these special deals meant that critics suddenly viewed Buffett as protecting the interests of entrenched CEOs. It was of course in the interest of his own shareholders to maximize their returns while protecting them from risk, but Buffett now looked like one of those boardroom insiders who depended on special deals to get ahead.

  In the age of the buyout funds and corporate raiders, this level of greed was chump change. Buffett could have easily been a buyout king himself. But what his determination to stay friendly and on the side of management did make clear was that he was now one of the guys at the country club. Ben Graham had always felt that if someone traded in stocks, this necessarily made him an outsider—because he had to be willing to displease a company’s management. Buffett, who wanted to be liked by everyone, had been trying to bridge that gap since his earliest investing days when he became friends with Lorimer Davidson at GEICO. Now, “Many Wall Street investors say Mr. Buffett’s special deals amount to a kind of gentlemanly protection game,” said one news story.33

  In the end, what looked like sweetheart deals turned out to be no more than finely handicapped bets. Only Gillette turned into a winner, ultimately earning Berkshire $5.5 billion. US Air was the worst. Buffett had made a number of remarks over the years about the stupidity of investing in things with wings. Then the company suspended its dividend and, like Cleveland’s Worst Mill, the stock plunged. “That was the dumbest fucking thing, going into that deal!” one friend exploded. “What the hell are you guys doing? You violated every one of your principles!”34 Buffett would later agree, saying, “As soon as the check cleared, the company went into the red and never came out. I have an 800 number I call and say, ‘My name is Warren Buffett and I’m an Air-aholic.”35 Charlie Munger’s dry comment was, “Warren didn’t call me on that one.”

  Salomon, the model for these deals, was also not doing well. After the crash and the near-escape from Perelman, the merger business had been slow to get back on its feet, and talented bankers left for elsewhere. Gutfreund had restructured the firm once again in another round of layoffs. But the managing directors no longer feared him. “People kept threatening John and he would try to buy them,” said one vice chairman. At first the firm had three, then seven vice chairmen. “Honk if you’re a vice chairman” became a joke around The Room.

  Already fragmented into disparate power bases, Salomon now evolved into a system of warlords: a corporate-bond warlord, a government-bond warlord, a mortgage-bond warlord, an equities warlord.36

  One ruled above them all: the warlord of bond arbitrage, a soft-spoken, brilliant mathematician, the forty-year-old John Meriwether. The shy, self-effacing “J.M.,” a former PhD candidate, expressed his outsize ambitions through a team of professors he had lured with Wall Street salaries from schools like Harvard and MIT. These “arb boys” hunched protectively over their computers, fiddling with mathematical models portraying the bond universe, an oasis of intellect amid the belching, sweating traders, who more often swung from their gut. Like handicappers assembling the financial version of the Daily Racing Form, the arbs were launching a revolution in the bond business, and the edge their computer tip sheet gave them against the rest of the suckers produced most of Salomon’s profits. They lived inside Meriwether’s little bubble on the trading floor and felt they had earned their arrogance. J.M. was enormously forgiving of mistakes but relentless toward anyone he considered stupid, and the arbs were his personally chosen elite. He had a deeply complex personal relationship with his team, and spent nearly all his time with them, engaging in one of his three obsessions: work, gambling, and golf. Many an evening after the markets closed the arbs sat together, playing liar’s poker to hone their handicapping skills.37 The boyish-looking, blank-faced Meriwether usually won.

  Despite his passivity and limited influence as a board member, Buffett certainly understood arbitrage. But the board’s knowledge of Salomon’s business details went only so far, and Buffett did not understand computers, which were becoming important to every business and intrinsic to the new Wall Street. He did know, however, that he was now a director of a corporation that was utterly dependent on computers, and he had certainly figured out that computers increased risk. He once visited Mark Byrne, the son of Jack Byrne, who traded foreign exchange options for Salomon.

  “Mark was bright and young, and he had a computer in his home so he could trade all the time. He had it rigged so that if the Japanese yen moved more than a certain amount, it rang a bell or something and woke him up in the middle of the night.

  “I said to Mark, ‘Now let me get this straight. You’ve got th
is computer here, and at three in the morning, after you’ve been doing who knows what—we won’t even ask—until one or two in the morning, you’re asleep, and this bell rings. And you get up and stagger over to the computer, and you see that the yen-dollar relationship is such-and-such.

  “‘Tell me, is there any limit to what you can punch in to the computer in terms of the size of the trade that you’d do? Does the computer rebel if you make a mistake?’

  “And he said, ‘No, I can type whatever I want.’

  “‘So,’ I said. ‘Well. If you’ve had a little too much to drink, and you punch three extra zeroes in there by mistake, is the firm committed? Does it have to follow through with the trade?’

  “And he said, ‘Yeah.’

  “So I had these nightmares of this guy, at three in the morning, maybe with a girl still in the bed or something, going over there in a daze and sort of punching something into the computer in the middle of the night and then staggering back to bed. And finding out the next morning that instead of a trillion yen, he’d put in a quadrillion yen.”

  To Buffett, it was obvious that the combination of fallible human beings and judgment-free computers in a completely unmonitored, unsupervised environment, meant an almost unlimited potential for things to go wildly out of control. But as a board member, he lacked authority to make changes and could only try persuasion. By now he and Munger had wrangled repeatedly—and unsuccessfully—with Salomon’s management. Munger had taken over the audit committee—which had not formerly been a bastion of zealous oversight—and put it through six-and seven-hour dissections of the firm and its accountants. Munger discovered that Salomon’s derivatives business had grown immensely, using trades for which no ready market existed. The trades would not settle for long periods, sometimes years. With minimal cash changing hands, the derivatives were valued on Salomon’s books using a model.38 Since the model was created by those whose bonuses it would determine, not surprisingly the models usually showed the trades were quite profitable. As much as $20 million of profits had been overstated through such accounting mismarks.39 The audit committee, however, addressed only trades and deals already approved, and usually completed. The real oversight took place before the fact.