The Snowball

by Alice Schroeder

  Buffett and Munger also learned about the time in early June when Gutfreund had met with Treasury Undersecretary Bob Glauber to defend the firm against accusations that it had engineered the May squeeze. They found out that Salomon’s management had considered whether to disclose the February false bid to Glauber immediately after that meeting, and had decided that the time was not right. Glauber later said he felt that he was played for a sucker because Gutfreund had not told him. Nothing had inflamed relations with the government and compromised Salomon’s credibility more than this meeting with Glauber. It smacked of an outright cover-up.

  The second press release that the board had approved, saying that the delay occurred thanks to “a lack of sufficient attention to the matter,” had made the board look like part of the cover-up, given that Gutfreund met with Glauber and clearly had the opportunity to tell him. But of course the board itself had been ignorant of the Glauber meeting.

  Buffett was angry that he had known nothing of these matters during the entire weekend of the crisis when he had been negotiating with the government. Everybody whose number one job was to protect the firm’s franchise had failed to do so and in fact had acted in a way that actually jeopardized it. Yet even with all of this to outrage him, Buffett still did not know about one last thing: the “cocked gun” Sternlight letter that had been sent and ignored.

  A few days later, the board met, and Buffett explained his thinking based on what he had learned. The board canceled the former executives’ magazine subscriptions. It took away their secretaries and got rid of chauffeurs and limousines. It cut off their long-distance phone service and messenger services. They were barred from entering Salomon’s offices. It tried to cancel their health insurance. Wachtell, Lipton offered to step aside as counsel. Initially, Buffett demurred, but then he agreed. The universal opinion was that Marty Lipton’s legal advice had not protected Salomon’s reputation.8

  Denham was now helping to oversee Salomon day to day. To augment the legal team for outside matters, Buffett brought in Ron Olson, the most recent name partner of Munger, Tolles & Olson, who had worked on the Buffalo Evening News case and now represented Berkshire Hathaway.9 MTO had finely tuned radar for how to get the best results for the client from the legal system—and a long-standing knowledge of how Buffett thought.

  Buffett told Olson that he wanted to pursue a novel strategy.10 Already staggering under the near-mortal blow to its reputation, Salomon could not, in his view, survive a criminal indictment.11 It was like a late-stage cancer patient. To save it, Buffett felt, radical techniques must be applied, even if it left the patient in a weakened state. The therapy he thought was Salomon’s best hope of avoiding a criminal indictment was to show extreme contrition. He would surgically dig out every last cell of the cancer and, with scorching radiation, cleanse the firm and burn out any trace of a recurrence.

  On Olson’s first day on the job, he was sent to see Otto Obermaier, the U.S. Attorney for the Southern District of New York, who would make the decision whether to criminally indict Salomon.

  “The argument we made to Otto Obermaier was that we would set an example. This was going to be an example of the most extraordinary cooperation that a target has ever given, and the outcome would have an effect on the behavior of future defendants and how the justice system worked.”

  Olson had to make an extraordinary pledge. On the spot, he waived Salomon’s attorney-client privilege, which shielded communications between the firm and its lawyers from prosecutors. He said that whatever MTO found in its investigation, Obermaier would know it as soon as MTO knew it.12 In plain English, this meant that MTO, on behalf of Salomon, had volunteered to act as an arm of the government.

  Obermaier was “incredulous,” Olson says. “He thought we were some Midwest aw-shucks group, come to sell him a bill of goods.”13 He could not believe that any company would make an offer voluntarily that was so against its own best interest. After all, Salomon was in no imminent danger of indictment. It would have months to prove its case. Clearly, this was more than a lip-service promise to “reform.”

  Then Olson flew to Washington and told Breeden at the SEC—who was “equally skeptical”—the same thing.14

  Initially, it was not clear what waiving the privilege meant. Frank Barron, an attorney from Cravath, Swaine & Moore, one of Salomon’s other law firms, was put in charge of negotiating what this extraordinary gift would mean to the Justice Department. Negotiating terms was difficult, since the commitment had already been made. Salomon had little leverage. The Justice Department pressed hard for a broad interpretation of the commitment and largely got its way.15 The agreement put the firm in a peculiar and paradoxical situation of prosecuting its own employees. The more evidence that MTO found that employees were guilty, the more proof it could show that Salomon had cooperated and cleansed itself. The employees, meanwhile, must cooperate or be fired, their statements to investigators unprotected by the normal attorney-client privilege.16

  Asked to help Buffett prepare for upcoming congressional testimony, Gutfreund and his lawyer met with Olson a few days later. Gutfreund had volunteered to cooperate, but when his lawyers tried to lay down ground rules for the conversation, Olson refused to accept them. In the end, Gutfreund and his lawyers walked out.17 Olson reported back to Buffett that he had been “stonewalled.”18

  Everything at Salomon was turned topsy-turvy as the new culture of openness went into effect. A couple of days after meeting with Obermaier, Olson and Buffett walked into a room at 7 World Trade Center for a meeting. Someone, acting on autopilot, had hired a new public-relations firm. Around a large square table, two dozen people sat waiting for them. Some worked for Salomon, but most were public-relations people and lobbyists who were billing by the hour. Buffett listened for fifteen minutes as they described how they wanted to manage the crisis. Then he stood up. “I’m sorry, but I’ve got to excuse myself,” he said. He leaned over, whispered in Olson’s ear, “Tell them they won’t be needed,” and walked out of the room.19

  “It isn’t that we’re misunderstood, for Christ’s sake,” said Buffett afterward. “We don’t have a public-relations problem. We have a problem with what we did.”

  On his birthday, August 30, Buffett went down to Washington. He had decided to prepare for upcoming congressional testimony and had arranged with Steve Bell, who ran Salomon’s Washington office, to gather a group to try to anticipate what questions the Congressmen might ask him.

  He checked in to the Embassy Suites hotel next to GEICO’s offices. As the emergency continued, he holed up in his room for two days. He encountered a telephone operator at the hotel, Carolyn Smith, who became his de facto secretary and Daisy Mae, manning the phones and sending cookies upstairs for him to eat for dinner. They never met in person, but when Nick Brady from the Treasury Department called, she got word to Buffett even when he was tied up on the single line in his room.20

  After a couple of days, Buffett found time to go over to Salomon’s fancy offices, where Bell had gathered people to brainstorm. Bell had called New York in advance, asking what to feed Buffett. “Something simple,” he was told. “Feed him hamburgers.” Bell was one of many people over the decades who thought this advice surely could not be literal. When lunchtime arrived, the chef sent out a plainly prepared fish course. Buffett didn’t touch it. Then came a pretty salad with a nice imported cheese. Buffett ignored it. Veal or something similar arrived as the third course. Buffett took a bite or two and pushed the food around on his plate. “Mr. Buffett,” Bell said, looking worried, “I’ve noticed you haven’t been eating your food. What’s wrong? Is there something else we can get for you?”

  “I follow a very simple rule when it comes to food,” said Buffett. “If a three-year-old doesn’t eat it, I don’t eat it.”21

  The following day, Buffett, Deryck Maughan, and Bob Denham went to the Rayburn House Office Building to testify before Congress. Katharine Graham showed up to lend moral support, sitting with Maughan and
Denham in the first row. Buffett made a striking impression, seated alone at the subcommittee table and pledging extraordinary cooperation with Congress and the regulators.22 “I want to find out exactly what happened in the past so that this stain is borne by the guilty few,” he said, “and removed from the innocent.”

  The Congressmen excoriated Salomon, postured as saviors of investors, and demanded a total break with the past. Nonetheless, they appeared slightly awed by Buffett. When he spoke, “The Red Sea parted, and the Oracle appeared,” says Maughan.23 Buffett laid the problems on Wall Street. “Huge markets attract people who measure themselves by money,” he said. “If someone goes through life and measures themselves solely by how much they have, or how much money they earned last year, sooner or later they’re going to end up in trouble.” Salomon, he said, was going to have different priorities from now on.

  “Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.”

  Those words have since been parsed and dissected in classrooms and case studies as the model of corporate nobility. Buffett’s unflinching display of principle summed up much about the man. In this statement, many of his personal proclivities—rectitude, the urge to preach, his love of crisp, simple rules of behavior—had merged. Openness, integrity, extreme honesty, all the things that he meant to stand for: Buffett meant for Salomon to stand for them too. If Berkshire Hathaway was his editorial page, Salomon would be the church of finance.

  Buffett headed back to 7 World Trade Center and put out a one-page letter to employees, insisting they report all legal violations and moral failures to him. He exempted petty moral failures like minor expense-account abuses, but, “when in doubt, call me,” he told them. He put his home phone number on the letter. We are going to do “first-class business in a first-class way,” he wrote.24

  He wanted to run things by what he called the “front-page test.” Don’t just obey the rules, he said.

  I want employees to ask themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper, to be read by their spouses, children, and friends, with the reporting done by an informed and critical reporter.25

  Employees at the time were frantically trying to keep from losing the firm. They called customers and begged them not to desert Salomon and ditched assets as fast as they could sell them because the debt that financed them was disappearing. John Macfarlane and the repo desk, which sold and bought batches of bonds, managed an intricate runoff of assets while negotiating tensely with numerous lenders, some of whom were refusing to advance money to the firm.26

  The balance sheet dwindled at the rate of about a billion dollars a day. Macfarlane and the traders met with lenders several times to make sure they were informed, and concentrated on stabilizing Salomon’s balance sheet and customer relationships, gradually raising the firm’s interest allocation charge and letting economics do the rest.27 They paid off all the firm’s commercial paper and restructured the debt toward medium-term notes and longer-term capital. Using futures markets and swaps (derivative trades), the firm’s traders tiptoed through the market to disguise the giant fire sale they were putting on. If other brokers recognized the pattern of their sales, it could set off a raid.28

  Under threat of indictment, it was far from certain that Salomon would survive. The employees understood the message of Buffett’s letter. Absolutely nothing else could go wrong in this atmosphere, with regulators and Congress in full cry. “I want every employee to be his or her own compliance officer,” Buffett said. This meant that to save the firm, they had to spy on each other. Meanwhile, everyone knew that MTO was crawling through the government desk like a minesweeper, looking for anything that could be wrong. As the customers fled, the trades shrank, and the fear spread, the firm’s long-standing culture of swashbuckling risk-taking began to fade.

  Within days, Buffett was called back, this time to testify before the Senate. Corrigan, Breeden, and the federal prosecutors remained disgusted with Salomon. As he waited to be called, seated a couple of rows behind Corrigan in the Senate chamber, Buffett heard Senator Chris Dodd question Corrigan about whether the Federal Reserve had been asleep at the switch.29 Corrigan said no, and that the Sternlight letter delivered on August 13 had been designed to produce a change in management but had been ignored—which, Buffett saw, he interpreted as Salomon spitting in his face.

  Buffett sat figuratively scratching his head. He knew there was some kind of major problem here, but he didn’t know what Corrigan was talking about.30

  When it came time for him to testify, he said, “The nation has a right to expect its rules and laws to be obeyed, and Salomon did not live up to this obligation.” Congressmen complained about Salomon’s excessive pay. How could one bond-arbitrage trader make $23 million? they asked. “That disturbed me plenty,” Buffett replied. They wanted to know what bond arbitrage was, and whether it benefited the economy. Buffett explained, then said, “If you asked me whether that compares to a good teacher in a public school, I would not want you to press me on it.”

  Why hadn’t a board filled with smart people been more aware and alert? a Congressman demanded. Without betraying the fact that he was steaming inside about the Sternlight letter—whatever that might be—Buffett said that management had withheld information.31 He acknowledged that Munger had been the only one smart enough to ask the right questions when the first phone call came.

  He was not about to defend Salomon as what it was: a great company with a wonderful culture that had a single employee who did a terrible thing, overseen by a management who mishandled the situation disastrously. Defending the firm of Liar’s Poker was not likely to win friends. No, Salomon was a financial Gomorrah that must be investigated and purged of its ticket-forging, bonus-pimping, pizza-tossing ways.

  This bold, arresting stance stopped a brewing witch hunt in its tracks. The pitchforks went back into the barns. The employees went along accordingly. “It was a brilliant strategy,” said Eric Rosenfeld. “That was our marching order, and we marched.”

  When Buffett got back to Salomon, he went after the details of the Sternlight letter; “he was livid,” according to board member Gedale Horowitz. “It compounded the felony. He was so angry because he hadn’t been told and the letter hadn’t been responded to.” Other than the Glauber meeting, the Sternlight letter was the most serious act of “information rationing.” Withholding it from the board had put them in the position of making a number of decisions in a state of ignorance about Corrigan’s expectations. Buffett’s and Munger’s attitudes toward prior management hardened. Now the real import of Munger’s term “thumb-sucking” became absolutely clear. “Thumb-sucking” meant ignoring the obvious until your diaper was full. Over a couple of weeks, said Munger, “We paid attention to our sovereign”—meaning the Treasury and the Federal Reserve—“and our views changed as our cognition improved.” As far as Gutfreund was concerned, “we had no option of forgiveness,”32 Buffett said.

  Through these revelations, Buffett led Salomon with apparent equanimity and poise, while Maughan and a few employees dressed in hazmat suits made up the cleanup crew. But beneath his eggshell-smooth demeanor, he was roiling in turmoil. To keep himself from thinking about Salomon, he played an electronic game called Monty for hours at a time. He hated being away from Omaha. Gladys Kaiser noticed the lift in his step when he returned and the drag in his feet when he had to leave. She wanted to retire but stayed on temporarily because her boss was having such a terrible year.33 New York did not suit him any more than it had when he was young and working at Graham-Newman. He remained aloof, never appeared on the trading floor, and, as one senior manager noted, even a glimpse of him in the hallways at Salomon was “a rare sighting.” Susie came out to visit from San Francisco. Kay Graham arrived to play bridge and keep him company. Before long, he had set up a regular game with Carol Loomis, George Gillespie, and Ace Greenberg, the CEO of
Bear Stearns. Bridge helped him relax because, when he played bridge, he couldn’t think about anything else. A couple of miles uptown, in his enormous Park Avenue apartment filled with a painstakingly assembled collection of art, his old friend Dan Cowin lay dying of cancer.

  Buffett wasn’t sleeping. When in New York, he would call home at twelve-thirty a.m., since he had the special deal to get the Wall Street Journal early in Omaha, and have tomorrow’s news read to him over the phone.34 He listened on tenterhooks, fearing that something horrible would be published about Salomon. Often there was, but at least he knew it before the rest of the employees, some of whom were seeing even less of their own homes than he was of Omaha. They were working fourteen or more hours a day to hold the firm together in the face of repeated obstacles and humiliations. Salomon’s stock and bond salesmen called clients knowing their main task was to convince them that the firm was not going under. Investment-banking clients were canceling previously committed deals as fast as they could run out the door. British Telecom threw Salomon out of the landmark deal that Gutfreund had gone to London to save, a trip that had caused him to miss the phone call with Buffett in Reno that revealed the emerging scandal. Bankers trying to sell other business faced an almost impossible task, as competitors used the firm’s precarious status against it when Salomon vied against them in banking “bake-offs.”35

  Other employees got field promotions of daunting magnitude. Maughan elevated one of the arbs, Eric Rosenfeld, to head trader, alongside Bill McIntosh, the head of sales. Rosenfeld, a former college professor who had never worked with a team of more than five people, suddenly found himself managing six hundred. Then the investigators threatened to fire some of his traders. And along with managing the six hundred, Rosenfeld personally reviewed thousands of trades for the lawyers to reconstruct what had happened.36