The Snowball

by Alice Schroeder

  Image 70

  Warren and Susie as Mickey and Minnie Mouse at an ABC-Cap Cities Event, 1997.

  Image 71

  Buffett rides a camel in China during a 1995 trip with Bill and Melinda Gates.

  The pyramided nature of the balance sheet of any investment bank was well understood by investors. Salomon was almost uniquely large, bigger than the biggest life insurer, second only to Citicorp in assets. As a major firm, Salomon’s debt desk had always acted as a broker to buy and sell the firm’s own medium-term notes. Suddenly, on Thursday, a long queue of sellers and no buyers appeared. In order to honor the sell orders, the traders had to buy the notes with Salomon’s own cash. Since nobody else wanted to buy the notes, they now amounted to merely pieces of paper that said that Salomon would pay Salomon in the future from Salomon’s own vault. But as the vault emptied, the notes were going to be worthless unless something changed. To conserve cash, the traders began to deter sellers by offering a lower price.51 Sellers quickly figured out what was going on. The line of sellers wanting to sell notes grew longer and longer.

  By the end of the day, Salomon’s traders had reluctantly bought $700 million of the firm’s own notes. Then they put up the “closed for business” sign, like a Depression bank snapping shut the teller’s window.52 No other firm would buy Solly’s debt either. And with that, Salomon was teetering precariously close to the edge of bankruptcy.

  The next morning, Friday, August 16, the New York Times front page ran a photograph of Gutfreund with the headline “Wall Street Sees a Serious Threat to Salomon Bros.—ILLEGAL BIDDING FALLOUT—High-Level Resignations and Client Defections Feared—Firm’s Stock Drops.”53 The story featured prominent photographs of Gutfreund and Strauss. The two of them and Marty Lipton called Corrigan’s office in New York and were patched through to Federal Reserve Chairman Alan Greenspan’s office in Washington, where Corrigan and Greenspan had been on a conference call with Treasury Secretary Nick Brady since dawn “trying to figure out who the hell we’re going to get to come in and run the firm.”54 Strauss, a longtime friend, knew they were in trouble when Corrigan greeted him as “Mr. Strauss.”55 The irate Federal Reserve Bank president, assuming that the board knew about the Sternlight death-threat letter, had been shocked by the latest press release they had issued. He interpreted their failure to take any action—such as firing senior management—as a sign that Salomon’s board was defying him.56

  Gutfreund said that he was going to resign. “What about Strauss?” asked Corrigan. With this, it became clear that, as far as the New York Federal Reserve was concerned, resigning was not optional, it was mandatory.57

  Gutfreund then called Buffett. It was six forty-five a.m. Omaha time and Buffett was still asleep when the phone rang. But he came to consciousness rapidly as Gutfreund, with Marty Lipton and Tom Strauss on the line, laid out the problem. “I just read my own obituary,” Gutfreund said, referring to the New York Times. His picture on the front page had done what the sequence of events—until then—had not. A freighted pause ensued, as Buffett understood what they were really asking him. He told them that he would consider taking over the job of chairman on an interim basis but needed to see the Times story first. He wanted a few minutes to think but was pretty sure he needed to go to New York. He told them that he would be there as soon as he could that afternoon. Marty Lipton said that it was unthinkable for Meriwether not to be fired immediately. Buffett insisted that they do nothing until he could at least talk to Meriwether.

  He hung up, called Gladys Kaiser at home, and told her to cancel a lunch with the president of Grinnell. Then he said, Call George Gillespie in Martha’s Vineyard. Cancel my trip for the weekend and put the pilot on alert that we may be going to New York.

  By the time he arrived less than an hour later at the office, still empty of staff, to read the “obituary” on the fax machine, he had made up his mind.

  Meanwhile, Gutfreund and Strauss had told Corrigan that Buffett was considering becoming interim chairman. “As far as I was concerned, they were both being less than candid with me,” Corrigan says. “I want to talk directly to Warren Buffett immediately,” he told them.58 “I didn’t know him personally, but I certainly knew his reputation.”

  Buffett for his part needed to find out how Jerry Corrigan would feel if he did take the job. It took some time to track down Corrigan in Washington. He did not call Buffett back until after eight-thirty a.m. CST, after the market had opened. Salomon’s stock did not open for trading, which told investors that major news was pending.

  When Corrigan talked to Buffett, he said something about his willingness to be a little more lenient about the “ten-day schedule” if Buffett took the job. Though Buffett did not grasp what Corrigan meant, he gathered that the Federal Reserve must have been asking for information about something. Corrigan sounded angry. He said that he would make no promises about anything if Buffett did take the job, and insisted that Buffett see him personally to talk about the role of interim chairman in New York that very night.

  At Salomon, all that the trading floor knew was that Buffett was supposedly flying in to rescue the firm and that Salomon’s stock was not trading. People speculated that he was considering Meriwether as a possible replacement for Gutfreund. The arb boys were crying, “We can’t lose John.” J.M. himself was nowhere to be seen. The trading floor stewed and seethed, but the stock was unable to open for trading because Buffett had told them to hold the press release, which announced that Gutfreund was prepared to resign and that Buffett was temporarily taking over as chairman, until after he arrived. With the stock hanging in limbo, news stories poured out on television that itemized Salomon’s problems and speculated what would come next.

  By early afternoon, Buffett had appeared. Once in the opulent executive suite on the forty-fifth floor, he hit the button on the press release, and the traders opened Salomon’s stock.59 It traded furiously for the final part of the day, closing up a dollar to almost $28.

  After the market closed, Buffett went down to the amphitheater for a meeting with the managing directors. Gutfreund and Strauss took the stage and Gutfreund said that they were prepared to resign.60 His face remained impassive, as usual. Strauss, noted Buffett, seemed shaken. Afterward, the senior management retired to the enormous conference room on the executive floor. Eric Rosenfeld and Larry Hilibrand, the key members of Meriwether’s team, bullied their way into the meeting.61 There, next to the wall of glass overlooking the two-story football-field-size trading floor where the trouble had begun, the top brass of Salomon began to thrash out what to do next.

  People holding different viewpoints started kicking Meriwether around like a soccer ball. Nobody disputed that he had done the right thing by reporting Mozer’s actions. The debate was whether he should have done more. Some people felt, as McIntosh articulated, that he was simply too close to the flame.62 Meriwether had a reputation as a tight manager; in his areas, as one said, “no sparrow fell that Meriwether didn’t see it.” Meriwether had not been involved in the false bids, but how could Salomon expect clemency while keeping him on? It seemed obvious to them that the government would treat the firm more harshly if he stayed. Although Strauss and Gutfreund were not present, they, too, had told Buffett that they thought Meriwether should resign along with them.63

  With uncanny timing, Meriwether himself arrived and leaned silently against a wall, watching as most of his peers demanded his head. Buffett had told Marty Lipton earlier that day that, unlike Strauss and Gutfreund, Meriwether must not be forced to resign (unless he chose to do so voluntarily). Buffett wanted time to deliberate. He did not agree with those who thought Meriwether had to go. Meriwether had not sucked his thumb; he had reported Mozer to Gutfreund and Strauss. It was not so much that they thought Meriwether had done anything wrong, Buffett decided. Rather, they were panicked. Their lives were simply going to be so much easier the next morning if Meriwether was gone. The consequences of putting his name in the press release now loomed larg
e to Buffett.

  After the meeting, he climbed into a waiting black Town Car with Gutfreund and Strauss and they wove their way through downtown rush-hour traffic to Corrigan’s office.

  Corrigan had felt it necessary to maintain his previous schedule in the interest of secrecy. He arrived directly from playing in the Federal Reserve’s annual officers-versus-employees softball game, his tall frame clad in jeans, sneakers, and a Liberty Street Blues T-shirt.64 But the chill in the air was such that “he could have been wearing black tie and I wouldn’t have noticed, given my state of mind,” Tom Strauss later said. Buffett opened disarmingly: “Look, the only thing I owe personally is $70,000 on a second home I have in California because the interest rate is cheap.” He promised complete cooperation with the regulators. Corrigan refused to be charmed. Interim chairmanships usually didn’t work very well, he said. Buffett had better not seek help for Salomon from his “Washington friends.”

  Corrigan demanded a thorough housecleaning. Buffett agreed to all sorts of fundamental changes to strengthen Salomon’s policies, controls, and documentation. “His verbal commitment to me was absolute,” says Corrigan, “and I trusted him.”

  Nevertheless, Corrigan made no promises. Giving Buffett a steely look, he said, “Prepare for all eventualities.”

  “It was a Dutch-uncle type of talk. It was cordial enough, but the Dutch-uncle aspect was there. We owed more money than virtually anybody in the country, and we owed it on very short terms. I tried once or twice to suggest how worried I was about the funding problem, hoping he might figuratively put his arm around me a little bit, but he didn’t do it. Prepare for all eventualities—that was something I didn’t know quite how to do. I certainly thought of strychnine or something of the sort.”

  Then Corrigan sent Buffett out of the room so he could talk to Gutfreund and Strauss. “You have a problem with an employee in your firm,” he said, “that’s his problem. You’ve got a problem with an employee in your firm and you fail to do something about it, that’s your problem.”65 Then, with tears in his eyes, he told them how much he regretted ending their careers.

  On the way out, while “Tom was in much more of a state of shock,” Gutfreund again seemed “quite composed.”66 He seemed to be blaming Corrigan for forcing him to resign. “I’ll be damned if I’m going to grant him absolution,” Gutfreund said.67 They rode back across downtown to Salomon, then went off to have a steak in a back room at Joe & Rose’s steak house on 49th Street. Strauss and Gutfreund insisted again that Meriwether had to go.68 They talked about the candidates for chief operating officer. Close to midnight, Buffett stumbled back to Katharine Graham’s apartment at the UN Plaza, and tried to sleep.

  Later, many people wrote many things about why Buffett took the job. Some said it was his $700 million, and some said it was his duty to the other shareholders. “Somebody had to take the job,” he said. “I was the logical person.” Other than the people who were resigning, no one had more at stake. But it was not just the money, it was what he cared about just as much: his reputation. When he invested in Salomon and gave John Gutfreund his imprimatur, it was like nailing that reputation to Salomon’s door like a shield.

  Buffett had told his children, “It takes a lifetime to build a reputation and five minutes to ruin it.” He thought of that risk primarily in terms of his own actions. Yet the people he had endorsed had put his reputation at risk. If he had made a mistake, it was to invest in Wall Street yet distance himself from it by relying on someone else; his judgment about Gutfreund’s ability to oversee the runaway culture of Salomon was flawed.

  By this time Buffett was the second richest man in the United States.69 Berkshire’s per-share book value had grown by more than twenty-three percent a year for twenty-six years. His first group of partners had an incredible $3 million for each $1,000 they had put in. Berkshire Hathaway was trading at $8,000 per share. Buffett had a net worth of $3.8 billion. He was one of the most respected businessmen in the world.

  At some point during that long, horrible Friday, he recognized with a sickening jolt that investing in Salomon, a business with problems over which he had essentially no control, had from the beginning put all that at risk.

  He did not want to become interim chairman of Salomon. That way lay greater peril. If Salomon went down afterward, he would be even more closely associated with shame and disaster. But if there was anybody who could get himself and the other shareholders out of this mess, he was that person.

  To do so he would have to extend the umbrella of his reputation, already at risk, even further to protect the firm. There was no way to avoid this challenge. Deryck Maughan and John Meriwether could not do it. He could not send somebody from Munger, Tolles, or Charlie Munger, or Tom Murphy, or Bill Ruane. He could not solve it by passing an idea along to Carol Loomis for an incisive article in Fortune. Even Big Susie could not solve this. For once, nobody could be his proxy. Only he could save Salomon. And if he walked away, the odds were high that Salomon would implode.

  There is an old saying in the military: To advance, a general must expose his flanks. Buffett could be a hero or he could fail. But he could not hide and he could not duck.

  At eight o’clock on Saturday morning, August 17, he arrived to a surreal scene at Wachtell, Lipton’s offices. Gutfreund was not there; despite miserable weather he had decided to fly up to his Nantucket house, where Susan was staying. All the warlords—theoretically, candidates for CEO—had begun to gather outside an “interview room.” Only a few of them made sense or actually wanted the job, but he had to interview every one. Meanwhile, a pair of “plenty smart,” tough investigative lawyers from Munger, Tolles—Larry Pedowitz and Allen Martin—gave “a masterful presentation” to Buffett and Munger, who had flown in to participate in person. For the first time—to their outrage—they learned that the Treasury Department had investigated Mozer’s earlier trades.70

  Next, Buffett had to make what he considered the most important hire of his life: to decide who would lead the firm. If he made a mistake, he could not reverse the decision later. Before starting the fifteen-minute interviews, he told the group, “J.M. is not coming back.”71

  With that, he began to interview the candidates one by one. He asked them all the same question: Who should be the next CEO of Salomon?

  “I was going into a foxhole with this guy, and he had to be the right choice. The question was, who would have all the qualities that would provide leadership to the firm, cause me not to worry for a second about whether anything was going on that was going to subsequently embarrass the firm or even put us out of business? As I talked to these people, what was really going through my mind was essentially the same questions that would go through your mind if you were deciding who you wanted to be a trustee under your will, or who you wanted to have marry your daughter, or anything of this sort. I wanted the kind of person who was going to be able to make decisions as to what should get to me and what could get solved below the line—who would tell me all the bad news, because good news always takes care of itself in business. I wanted to hear every bit of bad news as soon as it happened, so we could do something about it. I wanted someone who was ethical, who wouldn’t stick a gun to my head later on knowing that I couldn’t fire him.”72

  Buffett found that all but one of the other candidates thought it should be Deryck Maughan, who had returned three weeks earlier from running Salomon’s Asian operations.73 Maughan, forty-three years old, now headed the investment-banking group. He was not a trader, and he was English, not American. He had the least resemblance to Mozer or any of Salomon’s frat-house trading boys of anyone that could be found. He was viewed as both ethical and possessed of common sense. Thanks to Liar’s Poker, the public thought of Salomon as a place full of people who stuffed their faces with onion cheeseburgers for breakfast and dangled strippers’ panties from their trading screens.74 Salomon, after all, was the firm where, as Lewis had written, a vice chairman was more like a chairman of vice.75 Maugha
n, however, was the very portrait of a dignified, impeccably tailored Englishman. Since he had spent the past several years in Tokyo, the chance that he was tainted by the Treasury auction scandal was remote.

  Of all Maughan’s qualifications, possibly the most valuable was his distance from the crime. Within Salomon, land of the long knives, all of the other candidates had enemies. Maughan was a question mark, like the token black guy in the movie Putney Swope, who gets elected to the job of CEO of a backstabbing advertising agency when the old CEO croaks during a boardroom meeting. The other executives try to sabotage one another’s chances of getting his job by voting for Putney Swope, who ends up being elected by a huge majority.76 Maughan was respected, but no one knew him all that well. As one of the other warlords put it, they all voted for Maughan because it’s “better to choose someone you don’t know than someone you think is bad.”

  In the movie, Putney Swope had had the sense to vote for himself. When Buffett asked Maughan who should run Salomon, Maughan replied adroitly: “I’m afraid you’re going to find out that it’s me,” then added that he would serve whomever Buffett chose.77

  Two other things got Buffett’s attention. Maughan did not ask him for protection against being sued. And Buffett—who, as much as he hated admitting it, did not enjoy paying people—was mightily impressed that Maughan did not ask how much the job would pay.

  Maughan and two others were told to come to the office for the board meeting the next day. That afternoon, Buffett taxied back uptown to Graham’s UN Plaza apartment, where the arb boys met him to plead “with passion and logic” for Meriwether’s job. If J.M. left, Buffett knew, there had to be a risk that the arb boys would eventually join him.78 Without Meriwether, the main source of Salomon’s profits would drain away. Buffett’s investment in Salomon could become worth far less. Then Meriwether himself arrived, shaken. He did not want to resign, and he talked to Buffett at length. Buffett began to waver. He focused on Meriwether’s straightforwardness in reporting the problem.