The Snowball

by Alice Schroeder

  There, in the one area in which Buffett and Munger unequivocally had more skill than anyone else—making investments—they weighed in loudest of all—and were ignored. Their protestations only alienated them from the employees. In one example, Salomon’s Phibro unit had formed a joint venture with a seven-year-old Houston company, Anglo-Suisse, to build oil fields in West Siberia, south of the Arctic Circle, that would supposedly revolutionize oil production in Russia. The White Nights venture brought peace offerings to Russia, among them a recreation center, food, and clothing, all flown over from the United States.

  “Anglo-Suisse,” Munger said when the idea was floated. “This is an idiotic idea. There are no Anglos and no Swiss involved in this company. The name alone is reason not to get involved.”

  But Salomon put $116 million into the joint venture anyway, thinking that oil was going to be integral to Russia’s future and that Western capital was needed to extract the oil. But, while “the country isn’t going to go away,” as Buffett said, and “the oil isn’t going to go away,” the Russian political system could go away. No margin of safety could cover that.40

  Sure enough, as soon as the White Nights joint venture got going, the Russian government began toying with a tax on oil exports. The tax nearly wiped out White Nights’s profit. Then the volume of oil production proved disappointing. Russian nabobs flew to the United States and expected to be entertained with prostitutes. The Russian government was unpredictable and uncooperative, resulting in setbacks from start to finish. Somebody was going to make a lot of money from oil in Russia, but it wasn’t going to be Salomon Inc.

  Russia, however, was merely a sideshow at the time. In 1989, the United States had become obsessed with the possibility that the whole country would be eclipsed by the rising sun of Japan. Salomon had invested large sums in Japan and was doing well in its start-up business there, which had grown rapidly to hundreds of employees and was making money under its head, Deryck Maughan, who had wisely given local talent the reins. Buffett, who generally did not buy foreign stocks and who believed Japanese stocks in particular to be outrageously expensive, had shown little interest in anything related to Japan. Katharine Graham, however, had developed a fascination with Akio Morita, one of the world’s most brilliant businessmen. Morita was chairman of Sony, one of the world’s most successful corporations. Graham brought the two men together at one of her dinners, but they did not click.

  Finally, during one of Buffett’s trips to New York, Morita-san held a small dinner for Graham, Buffett, and Meg Greenfield at his Fifth Avenue apartment overlooking the Metropolitan Museum. Buffett, who seemed slightly mystified by Graham’s interest in this powerful, visionary man—observing grudgingly that Graham “was sort of enchanted by Morita”—agreed to go.

  Buffett had never eaten Japanese food but knew it might be problematic. He went to plenty of events where he touched nothing more than the dinner rolls. He could easily go seven or eight hours at a time without eating. He disliked offending his hosts, however, and as his reputation had grown, he found that there was no way to fake eating by cutting things up and moving them around. People noticed.

  One side of the Moritas’ apartment had a sweeping view of Central Park, the other a sweeping view of the sushi kitchen. A highlight for guests was the opportunity to watch the four chefs preparing the elaborate meal behind a glass window.

  As they were seated for dinner, Buffett looked at the chefs. What was this going to be like? he wondered. As guest of honor, he was seated facing the kitchen. There were chopsticks on a little stand and tiny cruets and miniature bowls of soy sauce. He already knew he didn’t like soy sauce. The first course was brought out. Everyone slurped it down. Buffett mumbled an excuse. He motioned for his full plate to be taken away. The next course arrived. Buffett could not identify it but looked at it with dread. He saw that Meg Greenfield, who had eating habits similar to his, also was having difficulties. Mrs. Morita, seated next to him, smiled politely and barely spoke. Buffett gurgled another excuse. He nodded again for the waiter to remove his plate. As his untouched dishes returned to the kitchen, he was sure the chefs noticed.

  The waiter brought out another unidentifiable course of something that looked rubbery and raw to him. Kay and the Moritas tucked in with enthusiasm. Mrs. Morita smiled politely once again when he offered a third excuse. Buffett squirmed. He liked his steaks bloody but did not eat raw fish. The waiter cleared the plates. The chefs kept their heads down. Buffett was sweating. He was running out of excuses. The chefs looked busy, but he was sure they must be peeking sideways from behind the glass to see what he would do. Course after course arrived, and each of his plates went back, untouched. He imagined that he heard a slight buzz from the kitchen. How many more courses could there possibly be? He had not realized there were this many things on the planet that could be eaten raw. Mrs. Morita seemed slightly embarrassed for him, but he wasn’t sure, because she smiled politely all the time and said so little. Time crawled more slowly with each course. He had been counting, and the number of courses now exceeded ten. He tried to make up for his culinary lapses with witty, self-deprecating conversation about business with Morita-san, but he knew he was disgracing himself. Even in the middle of his bonfire of embarrassment, he could not help but think longingly of hamburgers. He was sure that the beehive in the kitchen was humming louder with every plate he sent back. By the end of fifteen courses, he had still not eaten a bite. The Moritas could not have been more polite, which added to his humiliation. He was desperate to escape back to Kay’s apartment, where popcorn and peanuts and strawberry ice cream awaited him.

  “It was the worst,” he says about the meal he did not eat. “I’ve had others like that, but it was by far the worst. I will never eat Japanese food again.”

  Meanwhile, hundreds of Salomon employees who would have crawled up Fifth Avenue on their knees blindfolded to eat this same dinner with the Moritas were instead dining at high-priced Japanese restaurants and mutinying over the size of their huge bonus checks. The hugeness of their checks was not the point. It was the hugeness of their checks compared with others’ huge checks that mattered. Buffett and Munger knew little of the trouble fomenting at Salomon. Meriwether’s arbs had been agitating for more money. The former college professors, hired away from salaries of $29,000, felt they were subsidizing money-losing departments like equity investment banking. They viewed sharing their profits as “socialist.”41 The arbs could have made more on their own. They wanted a cut of the hundreds of millions they earned for the firm.42 Although he was so shy that he had trouble maintaining eye contact, Meriwether now became the world’s most aggressive and successful bonus pimp. Gutfreund caved and gave the arbs fifteen percent of what they made,43 which meant they had the potential to come away with much more money than the traders, who shared their bonus pool. The deal was made in secret between Gutfreund and Salomon’s president, Tom Strauss; the board never knew, nor did other employees at Salomon—yet.

  By 1991, Buffett and Munger had been through a series of disappointments and setbacks at Salomon. The financial results they got were not always up-to-date. Staff demands for bonuses continued to spiral. They disagreed with much of what went on in the boardroom. The stock price had not moved for eight years. Earnings were down $167 million, mostly because of employees’ pay.

  Buffett, having so far let Munger be the Appointed Bad Guy, now roused himself, met with the executive committee, and told them to cut back. Yet when the final bonus pool number came through, it was $7 million higher than before. Under the new formula that Meriwether, as bonus-pimp, had procured for his arb boys, one of them, Larry Hilibrand, got a raise from $3 to $23 million.44 When word of Hilibrand’s bonus leaked to the press, some of his colleagues went crazy with envy and felt cheated—the millions they were making forgotten.

  Buffett himself had no problem with the arbs’ bonuses. “I believe in paying talent,” he says, “but not, as Charlie would say, as a royalty on time.” The arran
gement was like a hedge fund’s fee structure and bore some resemblance to his old partnership.45 It would put more pressure on the rest of the firm to perform. What he objected to was not being told. He objected even more to the fact that other people did not get haircuts for their lack of performance. Gutfreund had showed a better sense of proportion than most of his traders, opting to take a thirty-five percent pay cut, in line with the decline in earnings.46 This helped him with Buffett, who thought Gutfreund had more class than his employees. But Buffett’s sense of decency was so offended by the employees’ greed that he overcame his natural inertia and voted against the bonuses for the traders. He was overruled. When word of Buffett’s “no” vote raced through the hallways of Salomon, people were outraged. A billionaire who loved money had called them greedy.

  Buffett considered Salomon a casino with a restaurant out front.47 The restaurant was a loss-leader. The traders—especially Meriwether’s people—were the casino: the purity of risk-taking done without conflicts of interest. That was the part of the business Buffett liked, and the new pay system was designed to keep the arbs from bolting.48 But by trying to operate the firm under two distinct pay systems, as if it really were a casino with a restaurant out front, Gutfreund had driven a rift through Salomon’s heart.

  Now Meriwether and Hilibrand asked Gutfreund for permission to approach Buffett to buy back his convertible preferred stock. The terms were so rich that it was costing Salomon too much. They were no longer under threat of a takeover. Why pay for Buffett’s protection? Gutfreund said they could talk to Buffett and try to convince him he was better off without the preferred stock. When approached, Buffett said that he was amenable. But having Buffett as an investor must have made Gutfreund feel more secure, for in the end he got cold feet.49

  Thus, Buffett was held to his original deal. Having invested both Berkshire’s $700 million and his own reputation in John Gutfreund, by 1991 it was too late to back out.

  48

  Thumb-Sucking, and Its Hollow-Cheeked Result

  New York City • 1991

  On Thursday afternoon, August 8, 1991, Buffett was driving to Reno, Nevada, from Lake Tahoe on his annual weekend with Astrid and the Blumkin boys. He always looked forward to this trip and was in a relaxed and jovial mood. John Gutfreund’s office had called him that morning. Where will you be tonight between nine p.m. E.S.T. and midnight? they asked. We want to talk to you.

  Thinking this was really unusual, he said he was going to a show. They told him to call Wachtell, Lipton, Rosen & Katz, the law firm that represented Salomon, at seven-thirty p.m. Hmm, he thought. Maybe they’re going to sell the firm. It sounded like good news to him. The stock was trading around $37, close to $38, the price at which his preferred stock would convert to common, and he could take his profits and be done with Salomon. Gutfreund, who had a long-standing habit of calling him for advice, might need help in negotiating terms.

  Buffett and company whiled away the afternoon in Reno. Buffett reminisced. In 1980 he had been offered the entire contents of a Reno landmark, the Harrah Collection from the National Automobile Museum: 1,400 cars covering acres and acres, a 1932 Rolls-Royce salamanca, a 1922 Mercedes Targa Florio Racer, a 1932 Bugatti coupe, a 1955 Ferrari, a 1913 Pierce-Arrow. It would have cost him less than a million dollars for the whole collection. He had wavered, then passed. A few years later, part of the collection—hundreds of cars—had been gradually auctioned for a total of $69 million. One car, the Bugatti Royale, had recently been sold to a Houston real estate developer for $6.5 million.

  By seven-thirty p.m., they had returned to Lake Tahoe. “We got to the hotel and the rest of them went into the dining room of the steak house. I told them, ‘This may take a while.’ I found a pay phone outside on the wall and dialed in to the number they gave me.” Buffett expected to be connected with Gutfreund, but Gutfreund was on a plane from London, where he had been trying to save the firm’s mandate in an investment banking deal for British Telecom. His flight had been delayed, and Buffett sat on hold for quite a while as a conversation took place on the other end about whether to wait for him to arrive before continuing. Finally Tom Strauss and Don Feuerstein got on the phone to tell Buffett what was going on—or a version of it, anyway.

  Tom Strauss, forty-nine years old, was there to protect Gutfreund’s flank. He had been appointed Salomon’s president five years earlier, during the Great Purge of 1987.1 Responsible for the firm’s international business, he was also charged with the Sisyphean task of licking the perennially lagging equity division into shape. As recent history showed, however, management was not a skill cultivated at Salomon. The warlords reported straight to Gutfreund, to the extent that they reported to anyone at all. Their clout came from their groups’ production of revenues. Strauss might be technically president of Salomon, but he had been promoted so high that he now floated distantly above the trading floor like a helium balloon. Periodically, the warlords batted him out of the way.

  Don Feuerstein, the head of Salomon’s legal department, had once played an important role at the SEC and was regarded as an excellent technical lawyer.2 He was Gutfreund’s consigliere, nicknamed POD, the “Prince of Darkness,”3 for the behind-the-scenes dirty work he did. Salomon’s warlords, accustomed to doing whatever the hell they wanted, worked through lawyers who reported to Feuerstein, including Zachary Snow, the assistant general counsel assigned to the trading operations. The warlord structure made the legal department both powerful and weak; it stewarded the firm’s franchise in much the way that everything happened at Salomon: by catering to factions and reacting to events. Salomon’s trading culture had embedded itself so strongly that even Feuerstein was a trader, lovingly operating a wine syndicate on behalf of several managing directors. His fax machine constantly spewed forth notices of wine auctions that were a profitable sideline for the syndicate’s participants, its product more traded and collected than drunk.4

  This evening no one was toasting anything, however. Feuerstein knew that Buffett and Gutfreund were friends. He felt awkward giving sensitive information to Buffett when Gutfreund should have been in on the call. Using a set of “talking papers,” he and Strauss told Buffett that “a problem” had arisen. A Wachtell, Lipton investigation had uncovered the fact that Paul Mozer, who ran Salomon’s government-bond department, had broken the Treasury Department’s auction-bidding rules several times in 1990 and 1991. Mozer and his deputy, who was complicit, were now suspended, and the firm was notifying the regulators.

  Who the hell is Paul Mozer? Buffett wondered.

  Paul Mozer, thirty-six years old, had been swooped up by New York from selling bonds in the Chicago office. He was as intense as a laser beam and started his day before the sun came up, parked in front of a trading screen in his bedroom taking a call from London, then galloped a couple of blocks from his tiny apartment in Battery Park City over to Salomon’s enormous new trading room, housed in the gleaming pink-granite space of 7 World Trade Center. There he stared at another set of screens until past sunset, and oversaw twenty traders, most of whom towered over his short, wiry frame. Mozer was smart and hyper-aggressive, but he also struck people as frustrated and insecure, an odd duck. Although he’d grown up on Long Island, he seemed like a greenhorn from the Midwest among the slick New Yorkers. He had been one of Meriwether’s arbitrage boys until Craig Coats, the head of the government desk, resigned and he was asked to take over. Now he still worked for Meriwether, but was on the outside looking in at his former gang. Gutfreund, who was under pressure from Buffett and the board to improve the numbers, had added the foreign-exchange department to Mozer’s duties; in a few months he had turned a “black hole” around and made it profitable.5 So Gutfreund had reason to be grateful to Mozer.

  While Mozer could be abrasive and condescending, as though he considered other people morons compared to himself, those who worked closely with him were fond of him. Unlike people on Salomon’s infamous mortgage desk, he did not abuse trainees by hurling food
at them or sending them racing out the door to buy twelve pizzas at a time. Sometimes he even talked to the trainees.

  For his labors, Mozer had been paid $4.75 million that year. It was a lot of money, but it was not enough. Mozer was World Cup–competitive, and Mozer was pissed. Something had snapped in him when he found out that his former colleague, Larry Hilibrand, had gotten 23 million bucks from a secret pay deal. He used to earn more than the arb boys,6 and he now went “ape-shit.”7 He copped such an attitude that he demanded that his department not be audited—as if, somehow, oversight did not apply to him.8

  Mozer was one of a few dozen men who communed regularly with the U.S. government on its financing needs, talking to the Federal Reserve staff nearly every day and dining quarterly with Treasury Department bureaucrats at the Madison Hotel. Representing Salomon as a “primary dealer,” he offered the government market chatter and advice and, in turn, stood first in line as its largest customer whenever the government wanted to sell debt, like a member of the College of Cardinals who sat at the right hand of the Pope.

  Only the primary dealers could buy bonds from the government. Everyone else had to do it by submitting bids through the primary dealers, who acted as brokers. This gave the dealers the clout that goes with access and enormous market share. Knowing the needs of both their clients and the government, the dealers clipped off a profit from the gap that lay between the supply and the demand. But with that position of power went a commensurate dose of trust. The government expected primary dealers to behave like cardinals who were celebrating Mass. Yes, they drank first from the communion cup, but they must not get loaded and embarrass the Church.