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Ajit had arrived at an opportune time. Insurance prices were peaking. He took an ad in Business Insurance magazine: “We are looking for more—more casualty risks where the premium exceeds one million.” The ad combined the showmanship and sharp thinking that were Buffett hallmarks. “We didn’t have a reputation, we didn’t have the distribution system,” says Buffett. But business came pouring in the door after that ad, and Ajit did deals, deals, deals.17

46

Rubicon

Omaha • 1982–1987

The 1980s would be an era of deals, deals, deals—most financed with debt, debt, debt. The Dow hadn’t budged in seventeen years.1 Grinding inflation had decimated corporate profits, yet companies had eiderdowned their payrolls so that every white-collar worker but the lowliest rested on a comfy cushion stuffed with flunkies. Executives treated themselves and their employees to golf courses and hunting lodges. They dribbled away much of their earnings in sloppy operations, loose engineering, and unthinking bureaucracy.2 By the early 1980s, stocks were on sale like polyester suits. Then, under Federal Reserve Chairman Paul Volcker, interest rates, recently an astronomical fifteen percent, started to fall as inflation came under control. Astute money men noticed the bloated state of American business. With debt now cheap, would-be buyers of a company could use the company’s own assets as collateral for a lender to finance its purchase—like getting a hundred percent mortgage on a house. The buyer didn’t have to put up any cash; it cost no more to buy a huge company than to set up a lemonade stand.3 A rush of financiers returned to Wall Street, intent on slaughtering the fatted calves using the carving knife of borrowed money. The merger boom had begun.

“We were taking earnings or value that should’ve gone to the shareholders and bringing it unto ourselves,” said Jerome Kohlberg, one of the first buyout financiers. “Corporate America was responsible for a lot of this. You have to ask the question, Why didn’t they do it [cost-cutting] themselves?”4

In 1984, the burner under managements turned up another notch when “junk bonds” became respectable. More politely called “fallen angels,” these were the bonds of companies like the Penn Central Railroad that were climbing out of the bankruptcy dustbin or teetering on its edge.5 Only occasionally did a company issue junk bonds on purpose, paying a high interest rate because it was considered a dicey credit risk. Junk bonds were sort of shady, a little desperate.

The people who worked in the junk-bond departments on Wall Street were junk peddlers or ragpickers—the few bankers who scouted for hag-ridden executives willing to issue junk bonds, and “distressed debt” analysts who spent their careers grading papers in the gloomy school of hard knocks, looking over picked-clean balance sheets and scuttlebutting bankruptcy lawyers, angry investors, and desperate managements.

Everything changed when Michael Milken, chief junk peddler of the upstart investment bank Drexel Burnham Lambert, rose to become the most influential man on Wall Street through a simple proposition: that while individual “fallen angel” junk bonds were risky, buying a bushel of them was not, because on average, the higher interest rate more than compensated for the risk. In other words, junk bonds in the aggregate had a margin of safety—like cigar butts.

Soon, money managers no longer looked as though they were playing roulette with investors’ money by putting high-paying junk bonds in their portfolios. Indeed, it quickly became more respectable to issue new junk bonds—quite a different thing. Another short hop and takeovers of strong, well-financed companies could be financed with junk, turning formerly sound balance sheets into debt-riddled Swiss cheese. Corporate raiders armed with junk bonds, intent on “hostile takeovers” whose goal was to pluck a company clean, suddenly stalked companies that had been waddling along complacently.