The Snowball_ Warren Buffett and the Business of Life - Alice Schroeder [317]
But to make big money on arbitrage—buying and selling two nearly identical things to profit from their difference in price—required scaffoldings of debt, in which more and more assets were sold short to buy more and more assets on the “long” side.48 This expansion of leverage from hedge funds and arbitrage was related to the rise of junk bonds and takeovers occurring at the same time. The models that supported the argument for leveraged buyouts using junk bonds were, like the models used by arbitrageurs, variations of the efficient-market hypothesis. Leverage, however, was like gasoline. In a rising market, a car used more of it to go faster. In a crash, it was what made the car blow up.
This is why Buffett and Munger considered defining risk as volatility to be “twaddle and bullshit,” as Munger would later put it. They defined risk as not losing money. To them, risk was “inextricably bound up in your time horizon for holding an asset.”49 Someone who could hold an asset for years could afford to ignore its volatility. Someone who was leveraged did not have that luxury—leverage costs; moreover the lender’s (not the borrower’s) time horizon defines the length of the loan. Thus a risk of leverage is that it takes away choices. The investor may not be able to wait out a volatile market; she is burdened by the “carry” (that is, the cost) and she depends on the lender’s goodwill.
But betting on volatility seemed to make sense when the market rose as predicted. When enough time passes and nothing bad happens, people who are making a lot of money tend to think it is because they are smart, not because they are taking a lot of risk.50
Throughout these profound changes in Wall Street’s ways, Buffett’s own habits had changed little.51 What still made his pulse race was buying a company like Fechheimer, which made prison-guard uniforms. People like Tom Murphy had to worry about whether they would be targeted by corporate raiders wielding junk bonds, but Berkshire Hathaway was impregnable because Buffett and friends of Buffett owned so much of its stock; his reputation made Berkshire a fortress where others could shelter. Berkshire had made $120 million on Cap Cities/ABC in the first twelve months it owned the stock; now the very mention that Buffett had bought a stock could, all by itself, move its price and revalue a company by hundreds of millions of dollars.
Ralph Schey, the head of Scott Fetzer, an Ohio conglomerate, got his company into a jam by trying to take it private in a leveraged buyout. With its stable of profitable businesses, from Kirby vacuums to the World Book encyclopedia, Scott Fetzer made appealing prey, and corporate raider Ivan Boesky quickly intervened to make a bid of his own.
Buffett sent Schey a simple letter saying, “We don’t do unfriendly deals. If you want to pursue a merger, call me.” Schey leaped at the proffer, and $410 million later, Berkshire Hathaway owned Scott Fetzer.52 Two and a half years after buying the Nebraska Furniture Mart, Buffett had bought a company eight times its size. For the first time, the CEO of a public—rather than private—company had approached Buffett because he would rather work for Buffett than work for (or be fired by) someone else.
The next to recognize the power of Buffett’s reputation was Jamie Dimon, who worked for Sanford Weill, the CEO of the brokerage firm Shearson Lehman, an American Express subsidiary.53 American Express wanted to sell its insurance arm, Fireman’s Fund, to Weill in a management buyout. Weill had already recruited Jack Byrne to leave GEICO and run Fireman’s Fund. Dimon approached Buffett to invest his