The Snowball_ Warren Buffett and the Business of Life - Alice Schroeder [398]
Meriwether, who knew that Buffett liked owning casinos, had gone to Omaha with one of his partners to try to raise money for Long-Term Capital for its February 1994 launch. They ate the now-obligatory dinner at Gorat’s, where J.M. pulled out a schedule over his steak to show Buffett different probabilities of results and how much money Long-Term could make or lose. The strategy involved earning tiny profits on many thousands of trades, leveraged by at least twenty-five times the firm’s capital. The highest loss that Long-Term contemplated was twenty percent of its assets, the odds of which it estimated at no more than one in a hundred.16 Nobody estimated the odds of losses bigger than that. (If they did, no one would invest; the numbers wouldn’t make sense. The projections in virtually all these types of models in every financial business always assumed the maximum “earthquake”-type loss could never happen—because the expected returns were never high enough to compensate investors for taking that risk.)
The name Long-Term came from the fact that investors were locked in. Meriwether knew that if he started losing money, he needed the investors to stay until the losses turned around. But so much leverage, combined with no way to cap the risk completely, made Buffett and Munger uncomfortable.
“We thought they were very smart people,” says Munger. “But we were a little leery of the complexity and leverage. We were very leery of being used as a sales lead. We knew others would follow if we got in.” Munger thought Long-Term wanted Berkshire as a “Judas goat.” “The Judas goat led the animals to slaughter in the stockyards,” he says, recalling Omaha. “The goat would live for fifteen years, and of course the animals that followed it would die every day as it betrayed them. Not that we didn’t admire the intellect of the people at Long-Term.”17
Long-Term charged its clients two cents off every dollar under management every year that they invested, plus a quarter of any profits it earned. Clients signed up for the prestige, but the “invest with a genius” approach put off other funds and firms on Wall Street. Nevertheless, it raised $1.25 billion, the largest hedge-fund start-up in history. The old arb team at Salomon now worked together in secrecy, with no outside interference and no more sharing of the profits with other parasitic Salomon departments. Indeed, the fund smoked in its first three years, quadrupling its investors’ money. By the end of 1997, Long-Term had amassed $7 billion of capital. Then competition from start-up hedge funds depressed returns. Meriwether sent $2.3 billion of money back to investors; the rest was all the market could digest. The hedge fund in Greenwich was now running more than $129 billion in assets—and a like amount of debt—on only $4.7 billion of capital. In a near-instant replication of Buffett’s steady accumulation of wealth, through the magic of fees earned on borrowed money, nearly half of the capital belonged to the partners themselves.18 Despite the fifty-year-old Meriwether’s difficulty making eye contact, he and his firm had a swagger to match their brilliant reputations, and the partners took full advantage of the fund’s position to dictate terms to its clients, to the fifty-something banks from which it borrowed, and to its brokers (in many cases these parties were one and the same).
Beating Buffett’s record was now the goal of most money managers in worldwide finance. Some thought Meriwether had at least an unconscious grudge against Buffett for failing to protect him at Salomon, then subsequently not hiring him back.19 Unbeknownst to anyone, Long-Term Capital was shorting Berkshire Hathaway, on the theory that BRK was overpriced relative to the value of the stocks that it owned.20 Not only that, Long-Term set up a Bermuda reinsurance