Buffett

by Roger Lowenstein

  † One skeptic was Rep. Howard Buffett, who in 1951 proposed a bill to protect holders of the Series E bonds against inflation.

  Chapter 21

  THE KING

  John Gutfreund runs an extremely good operation at Salomon.

  WARREN BUFFETT,

  BERKSHIRF HATHAWAY ANNUAL MEETING, 1991

  Appropriately enough, the origins of Salomon Brothers lay in a family quarrel. Ferdinand Salomon was born in Alsace-Lorraine, where the Salomons were money brokers. He emigrated to New York in the late nineteenth century and carried on the family trade, arranging short-term loans for securities firms. At the dawn of the new century, three of his four sons joined him. In those days, Wall Street was open for half a day on Saturdays. Ferdinand, who was orthodox, observed the Jewish sabbath; the sons insisted on working. In time, their rift became irreconcilable, and in 1910, the sons raised $5,000 and struck out on their own.1

  Setting up shop at 80 Broadway, the brothers went from bank to bank each morning, inquiring as to who had surplus funds and placing these funds with brokers. Gradually, they moved into corporate bond trading. Though its pedigree relegated it to a backwater, Salomon Brothers soon discovered a client that did not discriminate—the U.S. government. In 1917, Salomon became a registered dealer in Treasury securities. Later, it would be said that being a partner in Salomon was “the closest thing to being a partner in the U.S. Treasury.”2 But the firm remained small for many years. Two pivotal decisions would trigger its growth—and ultimately, would bring Warren Buffett to its door.

  From its inception, Salomon was scrappy and sharp-witted. Despite its humble origins, Arthur Salomon, one of the brothers, was one of the few people on Wall Street with whom J. P. Morgan, Jr., consulted. Once, while getting a shave, Salomon learned that Morgan needed to see him. With his whiskers yet untrimmed, he wiped the soap from his face and dashed to Morgan’s office. In return for such obeisance, the House of Morgan occasionally tossed a bone—such as a minuscule piece of a corporate bond underwriting—Salomon’s way.

  But Salomon was not content playing second fiddle. During the Depression, when the Morgans of Wall Street went on a “capital strike” to protest against the newly created SEC, Salomon stepped into the breach and got a toehold in underwriting.3 By such acts of brashness, coupled with its partners’ willingness to risk their capital, the firm prospered.

  Such was its growing strength that by the postwar era, a “marketable” bond was said to be one on which Salomon would bid.4 But it was still a niche player. Though feared as a bond trader, it remained an outcast in the snootier lines of underwriting and investment banking.

  In 1958, William Salomon revolutionized the firm in a single, brilliant stroke. A second-generation partner, Salomon decreed that each partner would have to leave his capital in the firm, save for a 5 percent annual draw. Younger partners, often eager to buy a home, would beg for an exception. The poised, dark-haired Billy Salomon would turn them down.5 The partners’ fates were thus intertwined, and a clannish spirit emerged. Moreover, the firm’s capital, then $7.5 million, began to grow.

  Salomon used its burgeoning capital to substitute for the corporate relationships that it had never had. It muscled its way into equities and investment banking, alongside the blue-blood Morgans and Kidder Peabodys. As recalled by Bruce Hackett, who was hired in 1968 as one of Salomon’s first stock salesmen:

  We were the last major house to get into research, the last to establish an investment bank. It wasn’t based on being close to customers. It was based on being close to markets. We were a pricing machine.

  In 1979, IBM asked Morgan Stanley to relinquish its traditional role as a sole manager of underwritings and comanage a $1 billion debt offering with Salomon. When Morgan refused, IBM stunned the old guard by choosing Salomon to lead the underwriting.6 There was no more dashing from barber stools to take calls from Morgan; Salomon had arrived. Its capital, by then, had soared to $200 million.

  By this time, Wall Street’s private firms had sensed the need for capital and had begun to sell shares to the public. Billy Salomon, who thought the discipline of the partnership was essential, was vehemently opposed to selling out. His protégé John Gutfreund agreed. Overhearing the partners discussing such a move one day, Gutfreund brusquely cut in, “If you fellows are thinking of doing anything like that I quit right now.”7

  Gutfreund had grown up in the tony suburb of Scarsdale, the son of a wealthy meat-truck-company owner who occasionally golfed with Billy Salomon. Intellectual and withdrawn, Gutfreund majored in English at Oberlin and considered a career in teaching. When he returned from service in Korea, Billy Salomon invited him downtown. Charmed by the energy of the trading floor, the stocky young man took a job as an apprentice.

  Working his way up through municipal bonds and syndicates, Gutfreund became a partner at thirty-four. He guided Salomon through a meteoric rise in underwriting, but was never quite one of the boys on Wall Street. During the Vietnam War, a bearded Gutfreund led a peace march through the financial district.8

  As if to compensate for being out of step, he developed a gruff, even a crude, exterior. Once, at a black-tie reception, he was introduced to Roland Machold, who ran New Jersey’s state pension fund. Dissatisfied with the amount of business he was getting from Trenton, Gutfreund blurted out, “Well, it ain’t worth fucking around with the state of New Jersey.”9

  Colleagues thought his rough language had a forced ring, as though, armadillo-like, it was covering up a shyness. Gedale Horowitz, a good friend at the firm, said, “John’s problem was he didn’t want people to know he was compassionate. He couldn’t get rid of the shell.”

  Billy Salomon, who thought Gutfreund would outgrow his bluster, tapped him to run the firm in 1978. Nothing could have prepared Salomon for the day in 1981 when Gutfreund, Henry Kaufman, and a third partner flew out to Salomon’s beachfront home in Southampton, New York. Salomon greeted them in casual slacks. His visitors were in pinstripes. They brought bitter tidings: they were selling the partnership to Phibro Corp., a publicly owned commodities trading firm. (Gutfreund had been reluctant to sell, but had bowed to his colleagues.)10 Salomon’s seventy partners reaped an average of $7 million apiece.

  Though Gutfreund could not have imagined it, the road from Southampton led inexorably to Omaha. Following the sale, Salomon had access to capital in the public markets, and the firm grew as never before. But the firm’s culture changed in ways that could not be undone. The executives continued to call each other “partners,” but that was a fiction. Now they had no money in the firm—no stake in it. “All of a sudden,” Billy Salomon recounted, “you had guys with five, six, ten million dollars. They were watching their money as much as the business.”

  Gutfreund assumed a dual chairmanship with David Tendler, the chief executive of Phibro. But Salomon hit its stride just as Tendler’s side of the business collapsed. Gutfreund promptly ousted him. By the mid-eighties, not only was Salomon’s traditional bond business soaring, but it was throwing its weight around in equities. It led the pack in underwritings and was enthroned by Business Week as “King of Wall Street.” Prophetically, the magazine added, “if for some reason the company stumbles and profits dwindle, Salomon is the kind of place where the long knives could come out in a hurry.”11

  Stumbling was the last thing on anybody’s mind. These were the years when Gutfreund ran the company from a desk in the fabled gym-sized trading room overlooking the Statue of Liberty. Short and thick-lipped, he would stroll past rows of traders, trailed by a vaporous cloud of cigar smoke. With his plum-sized jowls, he would lacerate underlings in full view of their peers. “He’d take someone to task,” a partner recalled. “He could turn you into a pile of shit on the floor.”

  Gutfreund was said to have dared his star bond trader, John Meriwether, to bet $1 million on a single round of liar’s poker, a game that traders played during lulls in the bond market. The incident, described in Liar’s Poker, a best-selling insider’s
account of the firm, was probably invented, but it enshrined Gutfreund’s image as a trader’s trader.*

  When not playing poker, Meriwether’s bond wizards, some of whom held Ph.D.s, made million-dollar bets on changes in interest rates using complex trading formulas. Gutfreund encouraged them to take risks and was manly about the inevitable loss. He inspired not only fear, but also intense loyalty.

  “It was striking how John dominated,” said Martin Leibowitz, the house mathematician. “He would walk the aisles. The electricity followed his path.”

  Gutfreund’s towering pride suffused the firm. His traders believed that a single moral lapse would be their last, and, indeed, Salomon went unscathed by the insider-trading scandals that sullied Drexel, Kidder, and Morgan Stanley. Imbued of old-school ethics, Gutfreund turned away clients that he deemed unsavory and rejected deals that he thought unsound.12

  And yet, eventually, he caved in, just as he had on selling the partnership. Giving way to his bankers, he let Salomon sponsor LBOs of Revco and Southland and authorized a junk-bond loan to TVX Broadcast. His vacillating—so at odds with his gruff facade—resulted in a trio of humiliating failures.

  Underneath, Gutfreund did not really have control. Departments were virtually unbudgeted. Salomon did not even have a chief financial officer until 1987. When the bond market collapsed that year, Gutfreund discovered—too late—that he had built a bloated staff. Since going public, the firm had tripled to 6,800 people. Gutfreund had poured capital into equities and investment banking but had yet to earn a decent return on them. In an eerie foreshadowing, he told the New York Times, “My problem is that I am too deliberate on people issues.”13

  His partners saw a pained quality to him, as in the doomed figures in the histories he devoured. Surrounded by antic traders, he strutted about the office like a stuffed bird. At a partners’ retreat on Cape Cod, Leibowitz espied him alone, brooding over a drink. When he asked what the matter was, Gutfreund said, “I can see my job will require me to hurt people I don’t want to hurt.”

  Struggling to get a grip, Gutfreund shook up the management time and again. Lewis Ranieri, a close colleague, had been running the mortgage department with virtual autonomy, as suggested by his traders’ habit of winging slices of tomato across the trading room. Gutfreund brutally fired him. But Salomon boiled over with rivalries between the lordly bond traders and the lesser-ranking bankers and salesmen. Well-known stars, such as deal-maker Ira Harris and bond-market guru Henry Kaufman, walked out. The long knives came after Gutfreund, too. There was a plot to unseat him, though it fizzled.

  At the heart of this Machiavellian infighting was the annual divvying up of bonuses. Gutfreund tried to hold them down, but he was continually bullied by Salomon’s princes, archdukes, vassals, and assorted subchieftains into raising the kitty.

  His troubles were inflamed by a seeming parallel between his business and private lives. Coincident with selling the partnership, Gutfreund had remarried, to a onetime Pan Am flight attendant and determined socialite. Previously retiring, Gutfreund became a Gatsby, and he and his wife spent an estimated $20 million on a Fifth Avenue duplex, which became the scene of fabulously lavish soirées. To top it off, Susan Gutfreund, blond and sixteen years her husband’s junior, bought a pied-à-terre in an eighteenth-century mansion on Rue de Grenelle, so that the Gutfreunds would have a place to repose in Paris.14

  The oft-repeated slap that she diverted him from Salomon was undeserved, but she aggravated a strain between Gutfreund and his partners, who felt they had to compete for the boss’s ear. Susan even overhauled their cherished executive meeting room, ditching their easy, bulky sofas for fluffy couches and antique ashtrays without so much as a word. “It looked a like a French bordello,” one partner groused. “I was walking around with a cigar in my mouth and I didn’t know where to put the ashes.”

  Increasingly, Gutfreund sought his counsel outside the firm. By the late eighties, he was dialing Omaha a couple of times a week. Buffett, his biggest shareholder, was inevitably supportive, and as Gutfreund confessed to Institutional Investor, he trusted Buffett more than he did his partners.

  I view Warren as a resource. I go to him if I’ve got something that I can’t ask anybody inside the firm about and get a reliable answer. Or, more than that, if I don’t trust the answer that I can get in the firm to be truly objective. Warren is a terrific call.15

  Buffett had been a fan of Gutfreund’s since the latter’s role in rescuing GEICO, in the mid-1970s. He had repeatedly cited Gutfreund’s “integrity.”16 But he and Munger were aghast at the chaos within the firm. They and the other directors did not even get an up-to-date balance sheet.17

  In 1990, Salomon Brothers’ profits plunged by $118 million. When Gutfreund then raised the total bonus pool by $120 million, Buffett was appalled. Salomon Brothers was earning 10 percent on equity pretax, far below the average of American industry. Its stock was mired in the low 20s—unchanged from eight years earlier (over which time the Dow had nearly tripled). Not a nickel of value had been built for stockholders, yet bonuses had risen in every year. As Buffett might have put it, the investment bankers were getting lavish “food stamps” at the expense of the stockholders. This violated everything Buffett believed in, and he was extremely unhappy about it.

  Late in the year, Buffett met with the executive committee—for him, a rare intervention in management—and told them to cut back. “I don’t care how you pay it—you can pay it all to one person,” said Buffett, who was one of three directors on the compensation committee. “But the overall number is wrong.”

  Gutfreund, who for once did not have Buffett in his hip pocket, ordered his managers to submit lower numbers. But by the time his underlords were through with him, Gutfreund had approved a revised bonus plan that was $7 million higher.18 †

  Buffett voted against the bonus plan—a singular instance of his voting against one of his managers. The other committee members voted in favor, averting a showdown. But the news that Buffett had voted against Gutfreund rocketed through Salomon like a thunderbolt. As Buffett explained later, he feared that an irrational pay scale was not a containable problem; such lopsided rewards would tend to produce “irrationalities” throughout the firm.19 And Salomon’s was very irrational; despite its poor results, no fewer than 106 executives had made at least $1 million.

  One trader in Meriwether’s elite bond arbitrage group had taken home $23 million! Though the group, and the trader, had earned immense profits for Salomon, news of his bonus raised an egalitarian uprising among other young traders, who were getting by on merely seven figures. In particular, Paul Mozer, the head of Salomon’s government bond desk, went “ape-shit.”20

  Mozer, given his thirty-four years, was in a position of considerable trust. An intense man with narrow-set eyes and wire-rim glasses, Mozer had grown up on Long Island and gotten an M.B.A. at Northwestern University. He joined Salomon as a bond salesman in 1979.

  In 1988, after a two-year stint in Meriwether’s group, Mozer was persuaded by Gutfreund to take over the government desk, a job he said was “second best.”21 Nonetheless, he worked constantly. He and his wife, who also worked on Wall Street, took an apartment in Battery Park City, within walking distance of Salomon. He installed a trading screen in his bedroom and customarily rose at six to take a call from London. Mozer made $4 million in 1989 and $4.75 million in 1990.22

  Even for a trader, Mozer was uncommonly edgy. When John McDonough, Salomon’s auditor, informed him that the government desk was due for an audit, Mozer exploded.

  “Look, my business runs fine.”

  “Paul, you don’t have authority to say you don’t want to be audited,” McDonough pointed out.

  “Every fucking time we try to do something intelligent we get beaten back,” Mozer stormed.

  When Meriwether, who was Mozer’s superior, was told about the incident, he chuckled, “You have to take Mozer with a grain of salt.”23 But no one questioned Mozer’s dedication.


  Mozer’s job was bidding for bonds at U.S. Treasury auctions and trading the bonds after they were issued. Treasury securities are the world’s biggest market, with some $100 billion in daily trading, compared to $8 billion or so on the New York Stock Exchange. The market was dominated by the “primary dealers,” a group of firms chosen by the Federal Reserve Bank of New York with which the bank did its trading. Though anyone could bid at a Treasury auction, only the primary dealers could also submit bids on behalf of clients. Thus they tended to know a great deal in advance about the tone of the market. And of the thirty-nine primary dealers, Salomon, the most venerable, took by far the biggest share of bonds.

  In return for its valuable imprimatur, Salomon, like the other dealers, was expected to help the government float its debt smoothly and to keep officials abreast of the bond market. Its traders chatted with their peers at the Federal Reserve virtually every day.

  The relationship was informal, and something of a throwback to a clubby, less regulated era of gentlemanly trust. Every quarter, a group of dealers and investors, including Salomon, were invited to the Treasury, where they were informed of the government’s funding needs and asked for advice on how to proceed. (The dealers were on their honor not to call their offices or trade on the news.) Then traders and bureaucrats would retire to the Madison Hotel for dinner, customarily of lamb chops.24

  Only at auctions were they on opposite sides, the dealers aiming for the lowest winning bid, the Treasury seeking the maximum price. Before each auction, traders such as Mozer frantically canvassed customers to size up demand. Meanwhile, Salomon and the other dealers stationed “runners” by a bank of phones in the Italian Renaissance Fed building. Seconds before the one o’clock deadline, the runners got their orders and wrote them out by hand. They dropped the bids into a wooden box. As the clock struck one, a Fed clerk put his hand over the slot.