Buffett

by Roger Lowenstein

  Even with his now immense fortune, Buffett continued to live simply, at least in Omaha. He drove his own car, a Lincoln, to the modest suite at Kiewit Plaza, where he and a staff of five ran the corporate affairs of Berkshire. His principal diversions were bridge, reading business books, and watching sports and talk shows. When he and Astrid went out, it was usually to Gorats, an unprepossessing Omaha steakhouse, owned by a former grade-school classmate of Buffett’s.

  Increasingly, though, Buffett’s world—his friends, his companies, his writing—extended beyond Omaha. His fortieth-birthday party had been on a golf course in Omaha; for his fiftieth, in the summer of 1980, Susie threw a black-tie bash at the Metropolitan Club in New York. Buffett got a giant bag of popcorn from Stan Lipsey and a succession of gags. Jerry Orans, his friend from Penn, was there, and Don Danly, from high school, Walter Schloss, aide-de-camp at Graham-Newman, Sandy Gottesman—he of the infamous toll-bridge quote—Kay Graham, Carol Loomis, and Marshall Weinberg. Buffett brought a copy of the balance sheet from Wilson Coin Op, his first business. Susie, the torch singer, sang an ode to her man. There were tributes from cronies, ending with a poignant toast from Munger.

  Underneath the partygoers’ merriment, there was probably no one in the great, wood-paneled room who did not feel that Buffett, in some way, was to leave a mark. With his scuffed shoes, grown-in but receding hair, and prominent beak, he looked more the professor than ever. Still slender, he had the unruly eyebrows of a thinker. Indeed, the revelers’ affection was fused with an excitement, even a certain idolatry. Whosoever owned stock in Berkshire—now quoted at $375 a share—was getting rich.

  The next year, Buffett had a dangerous close call. The wife of Rick Guerin, a money-manager chum of Buffett’s and Charlie Munger’s, died suddenly and tragically. Buffett, who was in Omaha, called Guerin at his home in California.

  “I’m hurting,” Guerin said.

  “I know how you feel,” Buffett replied. “I felt the same way when my father died, like someone beating me.”

  After a pause, he added, “Look, why don’t you and your son get on an airplane and we’ll meet up at Charlie’s island. We’ll just sit around for three or four days.”28

  Buffett and the others met at Munger’s cabin, on a lake in Minnesota. Munger took them fishing in an outboard motorboat, and as he was maneuvering in reverse, water rushed in over the gunwale. Guerin warned him to slow down, whereupon the half-blind Munger obstinately turned up the throttle. In an instant, the boat was underwater—and Buffett was trapped beneath it. The athletic Guerin managed to pull him out from under. Though they all made light of it—Charlie’s new sobriquet was “Commodore Munger”—Buffett was visibly shaken by his near-drowning.

  Guerin, though, was deeply touched by Buffett’s willingness to drop everything for him. “He has enormous compassion,” Guerin said, “but people don’t see that. To me it was just an amazing gift—the gift of time.”

  On Wall Street, Buffett’s letters had begun to circulate beyond the clique of his Rick Guerin-like admirers. Bankers were photocopying the reports and passing them around chain-letter style. For the first time, Buffett had a bit of a public following. As he wryly observed, Berkshire had “one-share subscribers” who bought a single share just to get the report.

  Munger said it was an accident that Buffett was running a public company—that he could have happily run a private portfolio from Omaha. But this does not take account of Buffett’s entertainer’s calling. In his letters, he found his stage. He would seize on an aspect of Berkshire—a wrinkle in its accounting, a problem in insurance—and veer off into a topical essay. In that respect, the letters were corporate oddities. One read the annual report of General Motors to learn about General Motors, not about the prejudices of any resident author-executive. The usual pose was Protestant and sober—what one would have expected from a Seabury Stanton. Buffett’s were replete with sardonic observations on sex, greed, human fallibility—and himself. The syllabus was that of the Harvard Business School, but the spirit was Poor Richard’s Almanac. And rather than explain business to just Kay Graham, he could do so for Wall Street, and for people across America.

  Jack Byrne, who knew Buffett, had the sensation as he read the letters of the scales falling from his eyes. Richard Azar, a young entrepreneur from Trinidad who did not know him, experienced an epiphany: when he was nineteen, Azar wrote, “God sent a blessed gift to me that came in the form of a Berkshire Hathaway Annual Report.”29

  One explanation is that these tours through American capitalism and the exploits of Berkshire had no parallel. Tycoons there had been, and also men of letters, but here, in one package, was a J. P. Morgan writing with the irreverence of Will Rogers. Buffett leavened the essays with cracker-barrel witticisms and nimble quotations (belying the notion that he was some sort of hick) from cultural icons such as Pascal, Keynes, Mae West, and Yogi Berra. But these were mere truffles. What set the essays apart was his knack for unbuttoning a complex subject and clearly explaining it.

  Through the early eighties one can discern three recurring themes. One was Buffett’s dread fear of inflation, inherited from his father. He seemed to have taken to heart Lenin’s dictum that the way to ruin capitalism was to ruin its money, and he doubted that politicians had the willpower to slow the printing press. Thus, Buffett saw inflation—as it turned out, erroneously—as a permanent affliction. “Like virginity, a stable price level seems capable of maintenance, but not of restoration.”30 Indeed, he feared that inflation might spell the demise of the long-term bond.31 This proved to be dead wrong.

  However, Buffett’s insights enabled him (and more attentive readers) to minimize inflation’s devastating consequences. His appreciation of its effect on the insurance business was especially dynamic. Inflation was destroying bond values, and the insurance industry had most of its capital in bonds—which previously had been the prudent course. What Buffett grasped was the vicious toll that the insurers’ investments exacted on their main business. As bond losses mounted, Buffett saw that insurers would be unwilling to follow their usual course of selling assets to pay off claims, because any company that unloaded bonds would have to admit to a crushing loss of capital. Then again, he recognized, the money that insurers had invested in bonds was not theirs to keep.

  For the source of funds to purchase and hold those bonds is a pool of money derived from policyholders and claimants (with changing faces)—money which, in effect, is temporarily on deposit with the insurer.32

  The alternative method of raising cash was for insurers to write more policies, which Buffett judged would cause the industry to write as much business as possible, driving premiums down to unprofitable levels and spurring huge losses in underwriting. All this unfolded as writ. Berkshire itself had minimal exposure to long-term bonds, the purchase of which, Buffett noted, was equivalent to “selling money” at a fixed price for thirty years. In an inflationary era, this was no less suicidal than agreeing to set a price on Hathaway yarn for the year 2010.

  Alas, understanding inflation did not provide immunity to it. Buffett pointed out, with no little agony, that when he had taken over Berkshire the book value of one share could have bought one half-ounce of gold and that, after fifteen years in which he had managed to raise the book value from $19.46 a share to $335.85, it would still buy the same half-ounce.33

  The best that he could do was to invest in companies that might resist inflation’s ravages, such as General Foods and R. J. Reynolds Industries. Buffett figured that well-known consumer brands, such as Post cereals and Winston cigarettes, would be able to raise prices at a pace with inflation. He also bought hard-commodity stocks, such as Aluminum Co. of America, Cleveland-Cliffs Iron, Handy & Harman, and Kaiser Aluminum & Chemical. But as Buffett would remind his readers, neither Berkshire nor anyone had a “remedy” for the problem. Inflation was a “gigantic corporate tapeworm” that “preemptively consumes its requisite daily diet of investment dollars regardless of the health of the
host organism.”34

  On Wall Street, inflation had triggered a frantic hunt for corporate assets. Companies, like people, were desperate to convert money to anything other than cash, igniting the takeover mania of the early eighties. Venerable names, such as Del Monte, National Airlines, Seven-Up, Studebaker, and Tropicana, were being swallowed up at huge premiums. This spurred the multimillionaire Buffett to adopt the unlikely role of one of Wall Street’s most scathing critics.

  In his view, the vanity of corporate CEOs was leading to irrational deals. CEOs were, by natural Darwinian selection, excessively energetic sorts, seldom “deficient in animal spirits.” They measured themselves by the size of their castle, rather than by Buffett’s yardstick of profitability (which to him was the only rational goal). Instead of buying small pieces of companies on the cheap, as Buffett did, these CEOs preferred to take full bites at more than full prices. Not to worry, though—these CEOs, being by the same Darwinian process an egocentric bunch, believed that their talents would justify their paying such lofty prices:

  Many managements apparently were overexposed in impressionable childhood years to the story in which the imprisoned handsome prince is released from a toad’s body by a kiss from a beautiful princess. Consequently, they are certain their managerial kiss will do wonders for the profitability of Company T(arget)…. We’ve observed many kisses but very few miracles.35

  Buffett wrote that for the 1981 report, when the merger wave was new. The next year, he could not resist a reprise. Many CEOs were paying for acquisitions by issuing shares. Buffett subjected this seemingly innocent technique to a rather savage dissection. In the first place, he observed, the acquiring CEOs weren’t only buying, they were also selling. With the issuance of new shares, each ongoing stockholder wound up owning proportionately less of the company than before. The CEOs disguised this fact by using the language of a buyer: “Company A to Acquire Company B.” However, “Clearer thinking about the matter would result if a more awkward but more accurate description were used: ‘Part of A sold to acquire B.’ …”36

  Why was this disguise employed? Most stocks, including most acquirers’ stocks, were cheap. In such a case, an acquiring CEO was shopping with unattractive currency, like an American in Paris when the dollar was undervalued. As he collected corporate trinkets he was parting with his own company on the cheap.

  Buffett suggested that such managers and directors could “sharpen their thinking” by asking if they would be willing to sell all of their company on the same basis as they were selling part of it. And if not, why were they selling part of it?

  A cumulation of small managerial stupidities will produce a major stupidity—not a major triumph. (Las Vegas has been built upon the wealth transfers that occur when people engage in seemingly-small disadvantageous capital transactions.)37

  What got under Buffett’s skin was that CEOs were enlarging their personal empires at the expense of shareholders—the very group they were pledged to serve. Such managers “might better consider a career in government.”38

  Buffett likened corporate kingpins to bureaucrats precisely because he knew it would taunt them. In life, Buffett was friendly with many of those CEOs; he sat on their boards. In his letters, he was careful not to name them. Still, he divorced himself from his natural corporate allies. (On white-collar crime: “It has been far safer to steal large sums with a pen than small sums with a gun.”)39 There was a whiff about him of Dust Bowl progressivism, yet Buffett was anything but a Prairie socialist. Where the latter loathed businessmen as capitalists, Buffett arrived at his critique via the opposite route. He attacked CEOs for being wards of the corporate state—that is, for being insufficiently capitalist and self-reliant.

  This suggests Buffett’s most pervasive theme, which was the proper relationship between corporate managers and shareholders, i.e., between the stewards of capital and its owners. In his view, the mangers of other people’s money bore a heavy burden, which he demonstrated in 1980, when a change in federal law forced Berkshire to divest the Rockford bank into a separate company. Buffett calculated that the bank was worth 4 percent of Berkshire; then he allowed each shareholder to choose between keeping his or her proportional stake in Berkshire and in the bank, or to take more of one and less of the other, depending on which slice (bank or Berkshire) a holder might prefer. The only one who did not get a choice was Buffett; he would take whatever shares were left. The principle was that he who cut the cake should be happy with the last slice.

  In the same spirit, in 1981, Buffett introduced a novel corporate charity plan, conceived by Charlie Munger. For each of its one million shares, then trading at $470, Berkshire would contribute $2 to charities of that shareholder’s choice. Someone who owned one hundred shares could designate the recipients for $200 in gifts, and so on. At other public companies, the choice of charities came from the CEO and the directors. (Only the money came from the stockholders.) Buffett saw this as sheer hypocrisy; not only did the CEO give away his stockholders’ dough, he then got to play the big shot at his alma mater, etc. Thus, “Many corporate managers deplore governmental allocation of the taxpayer’s dollar but embrace enthusiastically their own allocation of the shareholder’s dollar.”40

  By such words and deeds, Buffett was shaping Berkshire into a very personal vehicle. In effect, he was re-creating it as a public form of the Buffett Partnership. Some of his two thousand or so shareholders were in fact his ex-partners, though most were not. But one purpose of his letters was to attract and knit together a shareholder group who would behave like his partners—in other words, who would stick with him.

  The uniqueness of this approach is hard to overstate. At virtually every public company in America, high share turnover is not only the rule, it is devoutly encouraged by the executives. The typical CEO thinks of his investors as a faceless and changeable mass—to use Phil Fisher’s analogy, like the diners in a highway road stop. At Berkshire, the turnover was extremely low, which—as was clear from Buffett’s letters—was how he wanted his “café” to operate: “We much prefer owners who like our service and menu and who return year after year.”41

  Buffett scribbled his 7,500-word letters on a yellow legal pad, during family removes at Laguna Beach. He liked to imagine that his sister Roberta had been overseas for a year, and that he was writing to bring her up to date on the business.42 The letters were edited by Carol Loomis, his friend at Fortune, but they were Buffett’s creations and in fact sounded much as he did in conversation, full of homespun expressions and homilies.

  The reports were printed on coarse matte paper and bore merely the company name and a vertical black stripe on the cover. Inside, there were no snapshots of chocolates at See’s Candy, no photographs of Buffett and Munger with the pensive gaze that chief executives unfailingly employed for such occasions, no pyrotechnics with graphics-just a mass of type.

  In part, Buffett was good at writing annual reports because he was good at reading them. Such reports typically are slick public relations documents, intended to put a gloss on management’s performance and to attract new investors. Most contain only a perfunctory message from the CEO, and even that is typically ghostwritten. What Buffett missed in the hundreds that he read each year was a sense of the chief executive talking to him personally, and without the intrusion of professional hand-holders.

  Your Chairman has a firm belief that owners are entitled to hear directly from the CEO as to what is going on and how he evaluates the business, currently and prospectively. You would demand that in a private company; you should expect no less in a public company.43

  He was most unhappy with CEOs who resorted to that old Buffett bugaboo, changing the yardstick. When results disappointed, they adopted “a more flexible measurement system”: i.e., “shoot the arrow of business performance into a blank canvas and then carefully draw the bullseye around the implanted arrow.”44

  His primers on accounting in particular had a moral tone. Given that Wall Street cheers appeara
nces, a CEO with the slightest Pavlovian impulse will be tempted to dress up his company before taking it out. The danger is that, having fooled the public, the CEO will do likewise unto himself.45 Many run the business so as to maximize not the economic reality but the reported results. “In the long run,” Buffett warned, “managements stressing accounting appearance over economic substance usually achieve little of either.”46

  What should a CEO say to the public? In theory, he ought to describe the business from the same perspective that its managers did. Just as Buffett expected Ken Chace to give him a candid account of the textile mill, Buffett owed a similar candor (though not the same level of detail) to his public investors.

  Berkshire’s reports, in fact, disclosed enough information for readers to evaluate the company on the least favorable of terms. As during the partnership, Buffett repeatedly assured investors that there was no chance of maintaining prior rates of success. He was still the dutiful parishioner; confession soothed him. If there was a flaw in the reports, it was that Buffett was occasionally cloying and autoreferential. There was a winking quality to some of his gags, as though he were looking over his own shoulder. Moreover, his confessions of error and tongue-in-cheek self-immolations had a falsely modest ring. His humility wasn’t going to fool anyone—not with the stock in the stratosphere.

  In 1982, that stock hit $750 a share. This gaudy number reflected the gain in Berkshire’s stock portfolio, and that, in turn, was taking wing from developments in Washington. Paul Volcker, the Federal Reserve chairman, had been squeezing liquidity out of the system. The first effect was a recession, the second, an ebbing of inflation. By 1982, Volcker was sufficiently confident to loosen his grip on interest rates. The White House, meanwhile, was a picture of optimism. Ronald Reagan laughed off a would-be assassin and pushed through a tax cut.

  For so long, Wall Street had known nothing but fear. Now, as if a cat-footed clerk in a basement of its stone fortresses had thrown a master switch, brokers and bankers arrived at their desks with confidence. In the summer of 1982, interest rates tumbled … and tumbled … and tumbled. Treasury bills, quoted at 13.32 percent in June, stood at 8.66 percent in August. Stock prices, at first, resisted this stimulus. In August, stocks fell for eight straight days. The Dow stood at 777—well below its level of fifteen years prior. The Dow finally broke its losing string on Friday the 13th, gaining 11 points. Optimism was muted. On Monday, the Dow eked out a few points more. Then, on Tuesday, at precisely 10:41 A.M., Henry Kaufman, the perpetually gloomy Salomon Brothers economist with the coveted crystal ball, did a volte-face. Kaufman—a.k.a. Dr. Doom—declared that, counter to his previous sooth-sayings, he now expected interest rates to continue falling. The news sparked a buyers’ panic in stocks. The Dow rose 38.81 points—the biggest one-day rise in its history. The next day’s Wall Street Journal presciently reported: “Some are saying this is the start of the 1980s boom.”47 The earth had moved.