The Snowball_ Warren Buffett and the Business of Life - Alice Schroeder [325]
New York City • 1987–1991
Observers stood slack-jawed that the Midas from Omaha had gilded the mighty Salomon Brothers with his touch. Buffett—the burger-chomping billionaire next door, who drove an eight-year-old Cadillac, lived in his original $31,500 house, and possessed few of the tokens of the rich and famous—owned a major investment in a Wall Street bank.
He routinely railed against the Wall Street of which he was now very much a part. He wrote the Berkshire shareholders excoriating the junk bonds used to finance takeovers—including Salomon’s—which, he said, were “sold by those who didn’t care to those who didn’t think.”1 “I never talk to brokers or analysts,” he said. “You have to think about things yourself…. Wall Street is the only place people ride to in a Rolls-Royce to get advice from people who take the subway.”2 On the pages of the Washington Post, he had decried the “casino society” that was making the corporate raiders rich. Why not tax one hundred percent of the speculators’ profits?3 There was certainly a lot to tax. From 1982 to 1987, the Dow Jones Industrial Average had streaked from 777 to 2,722. If you want to make money, he told business-school students, “hold your nose and go to Wall Street.” But he was already there.
The image of Wall Street seducing a Midwestern populist into bed was too good to leave alone. Asked by a reporter why he owned the largest single chunk of Salomon when Wall Street was such a sinkhole, Buffett did not hesitate. He had placed his faith in one man. John Gutfreund, he said, “is an outstanding, honorable man of integrity.”4
Buffett always did fall in love with people, and observers said he was noticeably in love with Gutfreund—at first. Yet the man who once quit his job as a “prescriptionist” to escape the inherent conflict of interest with his customers couldn’t shield himself with John Gutfreund from the basic fact that he owned part of an investment bank, which was riddled with conflicts of interests with its customers. How had he gotten himself into the—at best awkward—position of sitting on the board of such a company?5 It was as if, during a dry spell, Buffett’s urge to make money had once again overwhelmed his high hopes, high aspirations, and high principles. And as had been true throughout his life, whenever his avarice got the upper hand, trouble followed.
At the time that Buffett invested in Salomon, the market was near a breaking point. In his shareholder letter the previous March, he had said that money managers were so hyperkinetic they made “whirling dervishes appear sedated.” He didn’t have a partnership to dissolve, but over the next few months he started dumping stocks. He knew that as the market continued upward, part of what was driving it was a new invention, the “S&P 500 future.” Salomon, like all major banks, now traded derivative contracts that were a way of betting how high or low the index of S&P 500 stocks would be on a certain date.6 Derivative contracts work like this: In the Rockwood Chocolate deal, the value of the futures contract was “derived from” the price of cocoa beans on a certain date. If the beans turned out to be worth less than the price agreed to by the contract, the person who had bought the futures contract as insurance “won.” Her losses were covered. If the beans were worth more, the person who had sold the futures contract as insurance “won.” The contract entitled him to buy the beans below the then-current market price.
Suppose that in the weight deal Buffett had made with Howie for the rent on his farm, he didn’t want to risk Howie’s actually losing weight, which would drop the rent. Since this was under Howie’s control, Warren might want to buy insurance from someone else. He could say to Susie, “Lookit, I’ll pay you a hundred bucks today. If Howie loses twenty pounds and keeps it off for the next six months, you’ll pay me the two thousand dollars of rent that I’ll lose. If he doesn’t keep it off for the whole six months, you don’t have to pay me the rent and you get to keep the hundred bucks.” The index that