On Thursday afternoon, August 8, 1991, Buffett was driving during his annual weekend with Astrid and the Blumkin boys in Lake Tahoe. He always looked forward to this trip and was in a relaxed and jovial mood. John Gutfreund’s office had called him that morning. Where will you be tonight between nine p.m. E.S.T. and midnight? they asked. We want to talk to you.
Thinking this was really unusual, he said he was going to a show. They told him to call Wachtell, Lipton, Rosen & Katz, the law firm that represented Salomon, at seven-thirty p.m. Hmm, he thought. Maybe they’re going to sell the firm. It sounded like good news to him. The stock was trading around $37, close to $38, the price at which his preferred stock would convert to common, and he could take his profits and be done with Salomon. Gutfreund, who had a long-standing habit of calling him for advice, might need help in negotiating terms.
At seven-thirty p.m., “We got to the hotel and the rest of them went into the dining room of the steak house. I told them, ‘This may take a while.’ I found a pay phone outside on the wall and dialed in to the number they gave me.” Buffett expected to be connected with Gutfreund, but Gutfreund was on a plane from London. His flight had been delayed, and Buffett sat on hold for quite a while. Finally Tom Strauss and Don Feuerstein got on the phone to tell Buffett what was going on—or a version of it, anyway.
Tom Strauss, forty-nine years old, was there to protect Gutfreund’s flank. He had been appointed Salomon’s president five years earlier, during the Great Purge of 1987.1 As recent history showed, however, management was not a skill cultivated at Salomon. The warlords reported to Gutfreund, to the extent that they reported to anyone at all. Their clout came from their groups’ production of revenues. Strauss might be technically president of Salomon, but he had been promoted so high that he now floated distantly above the trading floor like a helium balloon. Periodically, the warlords batted him out of the way.
Don Feuerstein, the head of Salomon’s legal department, had once played an important role at the SEC and was regarded as an excellent technical lawyer.2 He was Gutfreund’s consigliere, nicknamed POD, the “Prince of Darkness,”3 for the behind-the-scenes dirty work he did. The warlord structure made the legal department both powerful and weak; it stewarded the firm’s franchise in much the way that everything happened at Salomon: by catering to factions and reacting to events. Salomon’s trading culture had embedded itself so strongly that even Feuerstein was a trader, lovingly operating a wine syndicate on behalf of several managing directors. His fax machine constantly spewed forth notices of wine auctions that were a profitable sideline for the syndicate’s participants, its product more traded and collected than drunk.4
This evening no one was toasting anything, however. Feuerstein knew that Buffett and Gutfreund were friends. He felt awkward giving sensitive information to Buffett when Gutfreund should have been in on the call. A set of “talking papers” in hand, he and Strauss told Buffett that “a problem” had arisen. A Wachtell, Lipton investigation had uncovered the fact that Paul Mozer, who ran Salomon’s government-bond department, had broken the Treasury Department’s auction-bidding rules several times in 1990 and 1991. Mozer and his deputy, who was complicit, were now suspended, and the firm was notifying the regulators.
Who the hell is Paul Mozer? Buffett wondered.
Paul Mozer, thirty-six years old, had been swooped up by New York from the Chicago office. He was as intense as a laser beam and started his day before the sun came up, parked in front of a trading screen in his bedroom taking a call from London, then galloped a couple of blocks from his tiny apartment in Battery Park City over to Salomon’s enormous new trading room, housed in the gleaming pink-granite space of 7 World Trade Center. There he stared at another set of screens until past sunset, and oversaw twenty traders, most of whom towered over his short, wiry frame. Mozer was smart and hyperaggressive, but he also struck people as frustrated and insecure, an odd duck. Although he’d grown up on Long Island, he seemed like a greenhorn from the Midwest among the slick New Yorkers. He had been one of Meriwether’s arbitrage boys until the head of the government desk resigned and he was asked to take over. He still worked for Meriwether, but was now on the outside looking in at his former gang. Gutfreund, who was under pressure from Buffett and the board to improve the numbers, had added the foreign-exchange department to Mozer’s duties; in a few months he had turned a “black hole” around and made it profitable.5 So Gutfreund had reason to be grateful to Mozer.
While Mozer could be abrasive and condescending, as though he considered other people morons compared to himself, those who worked closely with him were fond of him. Unlike people on Salomon’s infamous mortgage desk, he did not abuse trainees by hurling food at them or sending them racing out the door to buy twelve pizzas at a time. Sometimes he even talked to the trainees.
For his labors, Mozer had been paid $4.75 million that year. It was a lot of money, but it was not enough. Mozer was World Cup–competitive, and Mozer was pissed. Something had snapped in him when he found out that his former colleague, Larry Hilibrand, had gotten 23 million bucks from a secret pay deal. He used to earn more than the arb boys,6 and he now went “ape-shit.”7 He copped such an attitude that he demanded that his department not be audited—as if, somehow, oversight did not apply to him.8
Mozer was one of a few dozen men who communed regularly with the U.S. government on its financing needs, talking to the Federal Reserve staff nearly every day. Representing Salomon as a “primary dealer,” he offered the government market chatter and advice and, in turn, stood first in line as its largest customer whenever the government wanted to sell debt, like a member of the College of Cardinals who sat at the right hand of the Pope.
Only the primary dealers could buy bonds from the government. Everyone else had to do it by submitting bids through the primary dealers, who acted as brokers. This gave the dealers the clout that goes with access and enormous market share. Knowing the needs of both their clients and the government, the dealers clipped off a profit from the gap that lay between the supply and the demand. But with that position of power went a commensurate dose of trust. The government expected primary dealers to behave like cardinals who were celebrating Mass. Yes, they drank first from the communion cup, but they must not get loaded and embarrass the Church.
As an auction neared, the primary dealers would work the phones, polling customers to gauge their appetite for bonds. Mozer’s sense of how hot the market was running translated into Salomon’s bid.
The inherent tension of the market lay in the opposing interests of the Treasury and the dealers regarding pricing and amounts. The Treasury auctioned only a certain amount of bonds and wanted the highest price, while the dealers wanted to pay just enough in the auction to win a larger share than anyone else yet no more than necessary, for that would hurt their profit on resale. So finely calibrated were these bids that the traders used increments of 1/1,000th of a dollar. That sounds like almost nothing, but clipping off 1/1,000th of enough dollars amounted to a fortune. On $100 million, it was worth $100,000. On a billion dollars, it was worth $1 million. Because government bonds were less profitable than mortgages and corporate bonds, Treasury bonds had to be traded in blocks this size in order for the dealers and money managers to make enough money for it to be worth their while.
Dovetailing with the need for such large trades was the government’s need to work with large dealers—those who knew the market well and had the power to distribute a lot of bonds. Salomon was the largest dealer by far. In the early 1980s, the Treasury had allowed any individual firm to buy up to half of a given bond issue for its own account. Salomon commonly “couped” an auction this way, then held on to the bonds long enough to “squeeze” anybody who was “short” Treasuries—having bet that prices would fall—because there were no bonds available for short-sellers to buy to cover their positions. Prices shot up, the short-sellers screamed, the trading floor erupted in cheers, and Salomon gloated over its huge profits and swung a big stick as the King of Wall Street. Couping the auctions fattened the usually thin profits on government bonds and sent a heady mist of testosterone drifting above the formerly stodgy section where the humdrum government-bond traders sat at their desks.
In response to grumbling, the Treasury lowered the limit and said no individual dealer could buy more than thirty-five percent, which made it harder to coup the auction. Smaller squeezes still occurred, but Salomon no longer owned the market unchallenged. Naturally, the new rule was unpopular at Salomon. Since the total of bids exceeded all the bonds on offer, the Treasury also prorated everyone, which meant a firm that wanted thirty-five percent had to bid more than thirty-five percent, a juggling act.
Thus in various ways the clampdown made it harder to profit at the government desk at Salomon. The mist of testosterone did not dissipate, however. Mozer tested the Treasury’s patience twice in 1990, bidding more than one hundred percent of all the bonds to be issued. Michael Basham, who ran the auctions, told him not to do it again. Mozer was sent to an “apology breakfast” with Bob Glauber, an undersecretary of the Treasury. He squeaked out some words but did not exactly apologize. He claimed that overbidding was in the government’s best interest because it increased demand for bonds.9 Not mollified, Basham changed the rules so that no individual firm could even bid more than thirty-five percent for its own account. The limit on bids meant Salomon might not even get its full thirty-five percent limit of bonds.
Now Feuerstein read Buffett a copy of a Salomon press release to be issued the next morning, which was being explained to all board members that night. It described how Mozer had responded to this stare-down with Basham. He had proceeded to submit unauthorized bids in excess of the government’s bidding limit in the December 1990 and February 1991 auctions.
Feuerstein gave Buffett a scripted version of events and told him that he had already spoken at length with Munger, who was at his cabin in Minnesota.10 Munger had said to him something about thumb-sucking and added, “People do that all the time.”11 Buffett recognized the term “thumb-sucking” as a Mungerism for procrastination but wasn’t terribly concerned. Feuerstein did not mention anything else discussed in the lengthy conversation with Munger, and Buffett did not ponder whose thumb was being sucked. Seven or eight minutes later he got off the phone, recognizing that this wasn’t the good news for which he had been hoping but not feeling alarmed enough to call Munger immediately. He’d check in with Munger over the weekend, he decided, but for now he was going to enjoy Lake Tahoe. Then he wandered back to join Astrid and the Blumkins in the dining room, where they were having a steak before seeing Joan Rivers and Neil Sedaka perform.
While Buffett was watching the show, John Gutfreund’s plane from London finally landed. Gutfreund and Strauss had a conversation late that evening with Richard Breeden and Bill McLucas, top officials at the SEC. They also placed a call to Gerald Corrigan, the beefy six-foot-four president of the New York branch of the Federal Reserve.
Using a different set of talking papers, Gutfreund and Strauss told Breeden, McLucas, and Corrigan more of the story than Salomon’s board had just heard. Mozer had not just overbid. To get around the thirty-five percent limit, at the February 1991 Treasury auction he had entered a fake bid in the name of a customer and stashed the bonds he got in Salomon’s account. In fact, he had placed more than one false bid in that auction. As to why these had not been reported earlier, they explained the delay as an oversight. Yet the SEC and the Treasury were in the midst of investigating Mozer, for he had pulled a huge squeeze in the May two-year-note auction. His actions were under intense scrutiny by regulators. That should have been true at Salomon as well. How could the delay have been an oversight? Now the regulators had to consider whether this confession indicated some major systemic problem at Salomon.
No matter what, these admissions were going to be highly embarrassing to the Treasury and the Federal Reserve. Corrigan was shocked that the firm had not already fired Mozer and created a remedial program that involved instituting all sorts of new controls. But he expected something like that to be announced within twenty-four or forty-eight hours, after which he could “keep them on probation for a while and hope that would be the end of it.” He told Gutfreund and Strauss that they had an immediate obligation to release this information to the public. Based on what he knew, he surmised that the incident could blow up into a “very, very, very significant problem.”12 It seemed to him, however, that Strauss and Gutfreund did not fully grasp this. Indeed, with hindsight, the fact that Gutfreund had gone off to London, thus placing his ability to participate in the calls with Buffett, Munger, and the other directors in the hands of an airline, was itself a telling sign.
The next day, Friday, August 9, Buffett was enjoying himself with Astrid and the Blumkins, walking along the board sidewalks of Virginia City, the old Western gold-rush town. He called in to his office. Nothing urgent was happening. Nobody at Salomon had called him. Salomon had put out the press release describing the events in fairly bland terms. The stock had fallen five percent, however, to $34.75.
Buffett called Munger on Saturday. Munger flatly told him a much more detailed and alarming story. Feuerstein had said that “one part of the problem has been known since last April.” While these same words had been read to the other directors, including Buffett, they had the effect of technically informing without really enlightening.13 But Munger picked up instantly on bullshit legalese and the passive voice, which irritated him. What did that mean, “has been known”? What exactly had been known? And by whom?14 When pressed, Feuerstein gave Munger a much fuller description of events, similar to what Corrigan had been told.15
As Feuerstein recounted, Mozer had gotten a letter from the Treasury Department in April saying they were investigating one of his bids.16 Realizing that the game was up, on April 25 he had gone to his boss, John Meriwether, and made a confession of sorts. In February, to get around the thirty-five percent limit, he had not only bid in Salomon’s name, he had also submitted phony bids under real customers’ names.17 Mozer swore to Meriwether that this was the only time, and he would never do it again.
Meriwether had recognized immediately that this was “career-threatening,” had said so to Mozer, and had reported the situation to Feuerstein and Strauss. On April 29, the three of them went to Gutfreund and told him what Mozer had confessed. Gutfreund, they said later, had been red-faced and pissed off when he heard the news.
Therefore, in April, Gutfreund knew. Strauss knew. Meriwether knew. Feuerstein, the general counsel, knew. They all knew.
Feuerstein had said at the time that Mozer’s actions appeared criminal. He didn’t believe that the firm technically had a legal reporting requirement. Still, Feuerstein was sure that Salomon would run seriously afoul of the regulators unless the Federal Reserve was told. Gutfreund said it would be taken care of. Curiously, however, no specific plans were made to march down to the Federal Reserve and give Jerry Corrigan the news. Moreover, having concluded that the phony bid was a “one-time, aberrant act,” they had left Mozer in charge of the government desk. Hearing this, “Well, that’s just thumb-sucking,” Munger had said. “People do that all the time.” He later explained that by thumb-sucking he meant “sitting there thinking and doggling, musing, and consulting, when you should be acting.”18
Munger told Buffett that he had challenged the press release: Shouldn’t management’s prior knowledge be disclosed? Feuerstein had said that, yes, it should be, but the decision had been made not to because Salomon’s management thought that disclosure would threaten the company’s funding. Salomon had tens of billions of short-term commercial paper debt that rolled over day by day. If the word got out, lenders would refuse to renew. To Munger, “funding difficulties” was shorthand for “financial panic.”19 Lacking the leverage to insist, he had given in, but he and Buffett now agreed that more disclosure was required. They mentally braced themselves for what would follow.
Two days later, on Monday morning, August 12, the Wall Street Journal reported the alleged details, with a blaring headline: “The Big Squeeze: Salomon’s Admission of T-Note Infractions Gives Market a Jolt—Firm’s Share of One Auction May Have Reached 85%; Investigations Under Way—How Much Did Bosses Know?” It mentioned the possibility of “civil charges of market manipulation, violations of the antifraud provisions of securities law, misrepresentations to federal authorities,” “books and records violations,” and “criminal charges” for committing “both wire and mail fraud.”20
Gutfreund called Buffett, sounding calm. Buffett thought that he seemed to believe the whole situation meant “a few points on the stock.” In light of the disastrous article, Buffett thought this attitude was unrealistic, a sign that Gutfreund believed the whole affair could somehow be finessed.21 It seemed of a piece with Gutfreund’s unwarranted composure the previous week. Buffett pressed for more disclosure. Salomon’s Treasury division was beginning to have trouble rolling over its commercial paper, meaning the firm’s lenders were starting to show signs of nervousness.22
Meanwhile, Munger was trying to get in touch with Wachtell, Lipton’s Marty Lipton, who was John Gutfreund’s indispensable best friend as well as Salomon’s outside counsel. So entwined with Salomon was Lipton that the speed-dial buttons on Donald Feuerstein’s phone rang his wife, the Sotheby’s and Christie’s auction houses, and Marty Lipton, not necessarily in that order.23 Lipton and his telephone were as inseparable as Buffett and his Wall Street Journal. Cell phones still being so rare, however, that even name partners of major law firms did not use them, Munger had to rely on Wachtell, Lipton’s office, which seemed to have a miraculous ability to track Lipton down, as Munger put it, “even in the middle of intercourse.”24
When reached, Lipton—who was presumably vertical at the time—was badgered by Munger for a follow-up press release, saying the first had been inadequate. Lipton agreed that the board would hold a telephone meeting to discuss it on Wednesday.
Not surprisingly, Jerry Corrigan at the Federal Reserve was even less satisfied than Munger with Salomon’s muted response. On Monday, August 12, he decided to have Peter Sternlight, one of his executive vice presidents, draft a letter to Salomon Inc. stating that the firm’s actions had called into question its “continuing business relationship” with the Fed, which was “deeply troubled” by the failure to make a timely disclosure of what the firm had learned. Salomon would have ten days to report on all “irregularities, violations, and oversights” that it had discovered.
In light of Corrigan’s earlier conversation with Strauss and Gutfreund, this letter would be a death threat. If the Fed cut off Salomon’s business relationship with the government, customers and lenders would desert in droves. The consequences would be huge and immediate.
Salomon had the United States’ second-largest balance sheet—larger than Merrill Lynch, Bank of America, or American Express. Nearly all of its loans consisted of short-term debt that was callable by lenders in days or at most weeks. Only $4 billion of equity supported $146 billion of debt. Dangling off the side of the balance sheet on any given day were tens more billions, perhaps as many as $50 billion a day, of uncleared trades—transactions executed, but not yet settled. These would stall midair. Salomon also had many hundreds of billions of derivative obligations not recorded anywhere on its balance sheet—interest-rate swaps, foreign-exchange swaps, futures contracts—a massive and intricate daisy chain of obligations with counterparties all over the world, many of whom in turn had other interrelated contracts outstanding, all part of a vast entangled global financial web. If the funding disappeared, Salomon’s assets had to be sold—but while the funding could disappear in a few days, the assets would take time to liquidate. The government had no national policy to provide loans to teetering investment banks because they were “too big to fail.” The firm could melt into a puddle overnight.25
Corrigan sat back in his chair, confident that once Salomon received Sternlight’s letter, management would understand the loaded gun cocked at its head, and would respond accordingly.
Within Salomon, after the press release and the Wall Street Journal story, rumors were running wild. Late Monday afternoon, it held an all-hands-on-deck meeting in its huge auditorium on its lowest floor. Nearly five hundred people crowded in, while hundreds, maybe more, from upstairs and from Salomon offices around the world, watched on television screens. Gutfreund and Strauss walked the audience through a baked-Alaska version of events, a crisp well-done meringue of a surface that hid the chilly surprise. Afterward, Bill McIntosh, the head of the bond department, was summoned upstairs to Gutfreund’s office, where he found Gutfreund, Strauss, and Marty Lipton, “three very scared men.” Earlier in the day he had been calling for Gutfreund’s head, but unexpectedly, they asked what he thought of the situation. McIntosh demanded more explanation; he felt the all-hands version and the press release had been misleading.26 He and assistant general counsel Zachary Snow ended up getting drafted to write another press release.
The next morning, McIntosh and Snow began drafting. Around midday, McIntosh went to tell Deryck Maughan, the vice chairman of investment banking, who had just come back from running the firm’s Asian operations, what was going on. Maughan knew he was hearing the harbinger of a disaster. He went to find Snow and pounced on him, saying you’d better be telling the whole truth to a vice chairman.
But Snow, who was in charge of legal matters for trading, had no intention of hiding anything from Maughan. He started talking, and a tale unfolded of what had transpired behind the scenes. He explained that in April, after Mozer made his first confession about the February auction, Meriwether had pleaded that Mozer not be fired, even though Feuerstein had said he believed Mozer’s actions were criminal in nature. Snow had been told—in confidence—about the situation. A month later, Mozer still ran the government desk; Feuerstein was nagging Gutfreund to come clean; Gutfreund was telling him that he would. But in fact no one had told the government. Meanwhile, Meriwether was charged with keeping an eye on Mozer, who had supposedly reformed.
Then Mozer had asked for funding to bid on more than one hundred percent of the two-year-note auction in late May. Even though some of the funding was supposedly to put in bids for customers, John Macfarlane, Salomon’s treasurer, had become alarmed. He thought it an obvious red flag and called a meeting with Snow and Meriwether. Snow had gone to Feuerstein, his boss, who agreed that it was an outrageous request. They had decided not to give Mozer the funds.27
But Mozer had secretly juggled the bids and money anyway.28 Managing to evade his overseers, he put in one suspicious bid and pulled off an enormous auction coup. Salomon wound up with eighty-seven percent of the Treasury bonds, and it and a small group of customers controlled the two-year notes afterward. The price shot up.29 Others’ losses from the “squeeze” topped $100 million, and several small firms suffered so severely that they filed for bankruptcy.30
Within Salomon, the squeeze had caused considerable angst. In the press, the firm was painted by its competitors as the pirate of Wall Street. The board members, including Buffett, had expressed outrage at a meeting that Salomon had cornered the market for two-year notes. Feuerstein had had Snow commence an internal investigation of the squeeze in June. As it turned out, Mozer had held a dinner with two hedge-fund customers right before the auction, and these customers had placed bids involved in the squeeze. With hindsight, the dinner pointed to possible collusion and market manipulation. But in the absence of proof, Mozer explained it away.31 Gutfreund had set up a meeting to see his overlords at the Treasury and the Fed to mend fences over the squeeze. When he went to see Glauber in mid-June, he sat on the sofa puffing a cigar. He offered a mea culpa to Glauber for the aftereffects of the squeeze and offered to cooperate with the Treasury—but defended Mozer against allegations of intentionally rigging the May auction. And he made no mention of what else he knew, leaving out anything about Mozer’s false bids in the earlier auction. In response to the squeeze and to the earlier run-ins with Mozer, however, unbeknownst to anyone at Salomon, the SEC and the Antitrust Division of the Justice Department began investigating the firm anyway.
About a week after the Glauber meeting, Gutfreund, Strauss, and Meriwether met to consider whether the firm should now come clean with the Treasury about the February auction. Because the hue and cry over the squeeze had not abated, they decided to keep silent. They felt the time was not right. Days later, the SEC sent Salomon a letter asking for information about the May auction. This was the first indication that the problem of the two-year-note auction might be escalating instead of fading away. Anyone receiving this inquiry letter might reasonably have gotten nervous about the SEC’s sudden interest in the operations of the government-bond trading desk.
Two days later, Gutfreund had flown to Omaha to visit Buffett, while on his way to Las Vegas to see some property that Salomon had financed. In telling the backstory to Maughan, Snow, who did not know about this trip, left it out. Buffett would later fill in these details.
“I picked him up at the airport. John was in the office for about an hour and a half. He spent about an hour making some calls, then we talked for about half an hour. He was sort of pacing around. We didn’t talk about anything in the end. It’s a pain in the neck to stop in Omaha, yet he really had nothing to say.”
Somewhat baffled as to the purpose of the visit, Buffett took Gutfreund to a quick lunch, then for a visit to the recently acquired Borsheim’s jewelry store, near the Furniture Mart. The proprietor, Ike Friedman, Mrs. B’s nephew, was cast in the same mold and, like her, somewhat larger than life.
Friedman took Gutfreund to Borsheim’s “center island,” where the really expensive goods were displayed. Gutfreund picked out a $60,000 item for Susan. It mattered to Buffett, Gutfreund said later, that he had made a purchase.32 Then he glanced at the expensive watches strategically displayed just behind the center island, and strolled over to look at the merchandise. Friedman preferred selling very expensive jewelry to timepieces. “Oh, watches,” he said to Gutfreund. “You lose them, you break them. Why pay a lot of money for a watch?” He looked at the fancy wristwatch on Gutfreund’s wrist and asked Gutfreund what he paid for it. Gutfreund told him.
“$1,995,”33 Friedman repeated. “Well. You got taken, John.”
“And you should have seen the look on John’s face.”
Wearing the watch on which he got taken, Gutfreund returned to New York at the end of June to present the satin-lined Borsheim’s box to Susan.
Within days—by early July—the Antitrust Division of the Justice Department formally notified Salomon that it was investigating the squeeze in the May two-year-note auction, which the letter from the SEC had inquired about. Gutfreund now got serious, said Snow, and hired Marty Lipton’s firm Wachtell, Lipton, Salomon’s outside counsel, to begin its own investigation, on behalf of Salomon, of the circumstances surrounding the May squeeze.34 People within Salomon had mixed views about the squeeze. Some said the Treasury market was inherently designed to be collusive. The job of a dealer was to work with its customers to distribute huge blocks of bonds into the market. Little squeezes happened all the time. This one was big. So what? The Treasury was picking on Salomon. It was the years of hubris, the wildness depicted in Liar’s Poker, the gradual erosion of power, that had made Salomon a punching bag.35
But others were furious that Mozer had once again defied the Treasury, and were baffled that he would pull a huge squeeze when it was well known that he and Basham were already at loggerheads. Later, these questions would increase. Why did Mozer—on probation, told his behavior had been “probably criminal”—taunt the Treasury so outlandishly that his coup splashed headlines all over the press, in a way guaranteed to draw even more attention to himself?36
A few days after beginning their work, the Wachtell, Lipton investigators were told that senior management had known since April that Mozer had submitted an unauthorized bid in the February auction.
With hindsight, Salomon’s actions looked far worse. After learning of Mozer’s false bid in February, which Feuerstein had said was criminal in nature, management had taken Meriwether’s vouching for Mozer and Mozer’s word that he had never done it before, without investigating further or disciplining Mozer in any way. They had left him in place, which allowed the May squeeze to occur. Once it did occur, telling the government Salomon knew about Mozer’s previous phony bids but had only now reported them would have caused more trouble by conveying the sense that they were a gang of thieves. Worst of all, Gutfreund had met with Bob Glauber in mid-June about the May squeeze, but had said nothing about all these earlier events. Now, as Snow explained to Maughan, when things started blowing up, everyone involved started excusing the original delay by saying the matter was a single minor event that caused no customer any harm, cost the government nothing, and didn’t make sense, even from the standpoint of the trader involved.37 Given the pressure of business, Gutfreund said, he simply hadn’t deemed it that important.38
Unfortunately, he was wrong about that. The Wachtell investigators had discovered that the February auction was not the only one that Mozer had rigged. They now knew that five auctions had been compromised.39 Two of these false bids had only just been unearthed. Snow concluded by telling Maughan about the previous evening’s meeting with all the inside and outside lawyers that had followed the half-baked explanation given to all employees. Snow had argued that management’s prior knowledge had to be disclosed. He was batted down. “I’m going to take a lot of heat for this,” Gutfreund told him. “I don’t see why you can’t do your part.”40
Maughan had been deeply concerned even before hearing all this new information from Snow. Seven days had passed since the first press release—seven days that included a salvo of stories in the media, the firm’s falling stock price, trouble rolling over the commercial paper, and the discovery of new false bids. By the time Snow finished telling him all of this additional history of what Mozer had done and what others had not done, Maughan blew up and started pounding Snow to make sure there was nothing else. Then he went down to the trading floor and confronted Meriwether, Mozer’s boss. “What the hell is going on, John?” he asked.
Meriwether hung his head. “It’s too late,” he said. He refused to talk further.41
Too late or not, Snow and McIntosh had to spend the evening drafting a second press release to try to explain things. That same night, Strauss and Gutfreund called Corrigan to respond in some fashion to the Sternlight “cocked gun” letter. The conversation started out with Corrigan being told that the firm had done an investigation and that “industry practice” of other firms was to pad their bids for new issuances of municipals and agency securities to get a bigger share. Corrigan viewed this opener as “a diversion, or worse.” It had nothing to do with the squeeze, nor with the more serious issue of phony bids—in fact, nothing to do with the Treasury market. His Irish temper ignited. He yelled into the phone at Strauss and Gutfreund: “This is your last chance. Is there anything else you have to tell me?” They began to describe the other violations.
Corrigan meant to put an end to the obfuscations and rationalizations. “Well, goddammit,” he said, “get yourselves together and release all of this information to the public immediately. I don’t want to hear anything else from you, just get that goddamn press release out.”42
Late that evening, the lawyers met with senior management to go over the press release. Gutfreund and Strauss arrived. McIntosh said there needed to be heads on a plate. This idea was quickly dismissed, but other people, including a board member, Gedale Horowitz, and Steve Bell, who ran Salomon’s Washington office, pressed for fuller disclosure. Nobody could get hold of Buffett, but they reached Munger on the phone, who said, Look, you can’t put this second press release out without names. Gutfreund’s name went in automatically. Everyone knew that Strauss was not in charge and had not made any of these decisions; he had simply been present in the room. But he had gone along with his boss. His name went in. Feuerstein had tried to get Gutfreund to report it. Munger said that his name should stay out.
Meriwether was known as a brilliant, careful manager who was unusually close to his team and rarely left the desk. He had reported the matter exactly as he should.43 On the other hand, he had vouched for Mozer, pleaded his cause, then left Mozer’s responsibilities unchanged. When Munger said Meriwether’s name should go in, says McIntosh, Meriwether, listening and seeing the lawyers write down his name, said, “Oh, my God, I’m doomed.”44
The next day, Wednesday, August 14, a telephone meeting took place in which the board heard some of the story that was given to Corrigan the night before. Two board members called in from Europe, one from Alaska, Buffett from Omaha, and Munger from Minnesota to hear the first “orderly and halfway complete description” of the Mozer affair. Inside Salomon, a palace coup was well under way, with senior managers talking to one another on the assumption that Gutfreund and Strauss would have to resign.45 The arbs wanted Meriwether as CEO, which was clearly unacceptable to many people. Meanwhile, on its conference call the board merely debated the wording of the new press release, which contained three pages of details and added the two additional violations that had been discovered by the investigators.
The draft release admitted that management had known about the February bids as far back as April but said that “the press of business” kept Salomon from reporting Mozer’s actions to the authorities. Buffett called this ridiculous, and as the board debated, Munger became incensed. Eventually, the press release was rewritten to say that the failure occurred due to “lack of sufficient attention to the matter.” Arrangements were made to put out the release that night.
As the meeting concluded, the board thought it had the full story. A number of things had not been mentioned, however. One was the “cocked gun” letter just received from Peter Sternlight at the Fed. Another was the June meeting with Bob Glauber at the Treasury Department, at which Gutfreund had failed to mention Mozer’s earlier activities.
That afternoon, Salomon held another all-hands-on-deck meeting in the auditorium. Bill McIntosh, who ran the daily sales meeting, stood at the front as usual and had the unenviable job of reading the new press release to the employees. With Gutfreund and Strauss in the front row, directly opposite him, McIntosh said, This is what happened. If customers call and want to know what’s going on, just tell them. Make no excuses for senior management, don’t apologize for them, they did what they did.
The morning after the press release appeared, Thursday, August 15, rumors floated that the long knives were out and McIntosh was a goner. He stayed on the floor all day, figuring that Gutfreund and Strauss wouldn’t fire him for insubordination in front of the whole trading floor. Meanwhile, market confidence in Salomon cracked. The stock, which had been sinking all week from the previous Thursday’s close of almost $37, slumped to $27. It was trading down because shareholders were beginning to suspect a bigger problem than Mozer’s misdeeds: a “run on the bank.” And, indeed, one was beginning to take place.
The pyramided nature of the balance sheet of any investment bank was well understood by investors. Salomon was almost uniquely large, bigger than the biggest life insurer, second only to Citicorp in assets. As a major firm, Salomon’s debt desk had always acted as a broker to buy and sell the firm’s own medium-term notes. Suddenly, on Thursday, a long queue of sellers and no buyers appeared. In order to honor the sell orders, the traders had to buy the notes with Salomon’s own cash. Since nobody else wanted to buy the notes, they now amounted to merely pieces of paper that said that Salomon would pay Salomon in the future from Salomon’s own vault. As the vault emptied, in order to conserve cash, the traders tried to deter sellers by offering a lower price.46 Sellers quickly figured out what was going on. The line of sellers grew longer and longer.
By the end of the day, Salomon’s traders had reluctantly bought $700 million of the firm’s own notes. Then they put up the “closed for business” sign, like a Depression bank snapping shut the teller’s window.47 No other firm would buy Solly’s debt either. And with that, Salomon was teetering precariously close to the edge of bankruptcy.
The next morning, Friday, August 16, the New York Times front page ran the headline “Wall Street Sees a Serious Threat to Salomon Bros.—ILLEGAL BIDDING FALLOUT—High-Level Resignations and Client Defections Feared—Firm’s Stock Drops.”48 The story featured prominent photographs of Gutfreund and Strauss. The two of them and Marty Lipton called Corrigan’s office in New York and were patched through to Federal Reserve Chairman Alan Greenspan’s office in Washington, where Corrigan and Greenspan had been on a conference call with Treasury Secretary Nick Brady since dawn “trying to figure out who the hell we’re going to get to come in and run the firm.”49 The irate Federal Reserve Bank president, assuming that the board knew about the Sternlight death-threat letter, had been shocked by the latest press release they had issued. He interpreted their failure to take any action—such as firing senior management—as a sign that Salomon’s board was defying him.50
Gutfreund said that he was going to resign. “What about Strauss?” asked Corrigan. With this, it became clear that, as far as the New York Federal Reserve was concerned, resigning was not optional, it was mandatory.51
Gutfreund then called Buffett. Buffett was still asleep when the phone rang, but he came to consciousness rapidly as Gutfreund, with Marty Lipton and Tom Strauss on the line, laid out the problem. “I just read my own obituary,” Gutfreund said, referring to the New York Times. His picture on the front page had done what the sequence of events—until then—had not. A freighted pause ensued, as Buffett understood what they were really asking him. He told them that he would consider taking over the job of chairman on an interim basis but needed to see the Times story first. He wanted a few minutes to think but was pretty sure he needed to go to New York. Marty Lipton said that it was unthinkable for Meriwether not to be fired immediately. Buffett insisted that they do nothing until he could at least talk to Meriwether.
He hung up, called Gladys Kaiser at home, and told her to cancel all his plans and put the pilot on alert that he might be going to New York. By the time he arrived less than an hour later at the office, still empty of staff, to read the “obituary” on the fax machine, he had made up his mind.
Meanwhile, Gutfreund and Strauss had told Corrigan that Buffett was considering becoming interim chairman. “As far as I was concerned, they were both being less than candid with me,” Corrigan says. “I want to talk directly to Warren Buffett immediately,” he told them.52 “I didn’t know him personally, but I certainly knew his reputation.”
When Corrigan talked to Buffett, he said something about his willingness to be a little more lenient about the “ten-day schedule” if Buffett took the job. Though Buffett did not grasp what Corrigan meant, he gathered that the Federal Reserve must have been asking for information about something. Corrigan sounded angry. He said that he would make no promises about anything if Buffett did take the job, and insisted that Buffett see him personally to talk about the role of interim chairman in New York that very night.
At Salomon, all that the trading floor knew was that Buffett was supposedly flying in to rescue the firm and that Salomon’s stock was not trading, which told investors that major news was pending. People speculated that he was considering Meriwether as a possible replacement for Gutfreund. The arb boys were crying, “We can’t lose John.” J.M. himself was nowhere to be seen. The trading floor stewed and seethed, but the stock was in limbo. News stories poured out on television that itemized Salomon’s problems and speculated what would come next.
By early afternoon, Buffett had appeared. He hit the button on the press release announcing that Gutfreund was prepared to resign and Buffett was temporarily taking over as chairman, and the traders opened Salomon’s stock.53 It traded furiously for the final part of the day, closing up a dollar to almost $28.
After the market closed, Buffett went down to the amphitheater for a meeting with the managing directors. Gutfreund and Strauss took the stage and Gutfreund said that they were prepared to resign.54 His face remained impassive, as usual. Strauss, noted Buffett, seemed shaken. Afterward, the senior management retired to the enormous conference room on the executive floor. Eric Rosenfeld and Larry Hilibrand, the key members of Meriwether’s team, bullied their way into the meeting.55 There, next to the wall of glass overlooking the two-story football-field-size trading floor where the trouble had begun, the top brass of Salomon began to thrash out what to do next.
People holding different viewpoints started kicking Meriwether around like a soccer ball. Nobody disputed that he had done the right thing by reporting Mozer’s actions. The debate was whether he should have done more. Some people felt, as McIntosh articulated, that he was simply too close to the flame.56 Meriwether had a reputation as a tight manager; in his areas, as one said, “no sparrow fell that Meriwether didn’t see it.” Meriwether had not been involved in the false bids, but how could Salomon expect clemency while keeping him on? It seemed obvious to them that the government would treat the firm more harshly if he stayed. Although Strauss and Gutfreund were not present, they, too, had told Buffett that they thought Meriwether should resign along with them.57
With uncanny timing, Meriwether himself arrived and leaned silently against a wall, watching as most of his peers demanded his head. Buffett had told Marty Lipton earlier that day that, unlike Strauss and Gutfreund, Meriwether must not be forced to resign. Buffett wanted time to deliberate. He did not agree with those who thought Meriwether had to go. Meriwether had not sucked his thumb; he had reported Mozer to Gutfreund and Strauss. It was not so much that they thought Meriwether had done anything wrong, Buffett decided. Rather, they were panicked. Their lives were simply going to be so much easier the next morning if Meriwether was gone.
After the meeting, he climbed into a waiting black Town Car with Gutfreund and Strauss and they wove their way through downtown rush-hour traffic to Corrigan’s office.
Corrigan had felt it necessary to maintain his previous schedule in the interest of secrecy. He arrived directly from playing in the Federal Reserve’s annual officers-versus-employees softball game, his tall frame clad in jeans, sneakers, and a Liberty Street Blues T-shirt.58 But the chill in the air was such that “he could have been wearing black tie and I wouldn’t have noticed, given my state of mind,” Tom Strauss later said. Buffett opened disarmingly: “Look, the only thing I owe personally is $70,000 on a second home I have in California because the interest rate is cheap.” He promised complete cooperation with the regulators. Corrigan refused to be charmed. Interim chairmanships usually didn’t work very well, he said. Buffett had better not seek help for Salomon from his “Washington friends.”
Corrigan demanded a thorough housecleaning. Buffett agreed to all sorts of fundamental changes to strengthen Salomon’s policies, controls, and documentation. “His verbal commitment to me was absolute,” says Corrigan, “and I trusted him.”
Nevertheless, Corrigan made no promises. Giving Buffett a steely look, he said, “Prepare for all eventualities.”
“It was a Dutch-uncle type of talk. It was cordial enough, but the Dutch-uncle aspect was there. We owed more money than virtually anybody in the country, and we owed it on very short terms. I tried once or twice to suggest how worried I was about the funding problem, hoping he might figuratively put his arm around me a little bit, but he didn’t do it. Prepare for all eventualities—that was something I didn’t know quite how to do. I certainly thought of strychnine or something of the sort.”
Then Corrigan sent Buffett out of the room so he could talk to Gutfreund and Strauss. “You have a problem with an employee in your firm,” he said, “that’s his problem. You’ve got a problem with an employee in your firm and you fail to do something about it, that’s your problem.”59 Then, with tears in his eyes, he told them how much he regretted ending their careers.
On the way out, while “Tom was in much more of a state of shock,” Gutfreund again seemed “quite composed.”60 He seemed to be blaming Corrigan for forcing him to resign. “I’ll be damned if I’m going to grant him absolution,” Gutfreund said.61 They rode back across downtown to Salomon, then went off to have a steak in a back room at Joe & Rose’s steak house on 49th Street. Strauss and Gutfreund insisted again that Meriwether had to go.62 They talked about the candidates for chief operating officer. Close to midnight, Buffett stumbled back to Katharine Graham’s apartment at the UN Plaza, and tried to sleep.
Later, many people wrote many things about why Buffett took the job. Some said it was his $700 million, and some said it was his duty to the other shareholders. “Somebody had to take the job,” he said shortly afterward. “I was the logical person.”63 Other than the people who were resigning, no one had more at stake. But it was not just the money, it was what he cared about just as much: his reputation. When he invested in Salomon and gave John Gutfreund his imprimatur, it was like nailing that reputation to Salomon’s door like a shield.
Buffett had told his children, “It takes a lifetime to build a reputation and five minutes to ruin it.” He thought of that risk primarily in terms of his own actions. Yet the people he had endorsed had put his reputation at risk. If he had made a mistake, it was to invest in Wall Street yet distance himself from it by relying on someone else; his judgment about Gutfreund’s ability to oversee the runaway culture of Salomon was flawed.
By this time Buffett was the second richest man in the United States.64 Berkshire’s per-share book value had grown by more than twenty-three percent a year for twenty-six years. His first group of partners had an incredible $3 million for each $1,000 they had put in. Berkshire Hathaway was trading at $8,000 per share. Buffett had a net worth of $3.8 billion. He was one of the most respected businessmen in the world.
At some point during that long, horrible Friday, he recognized with a sickening jolt that investing in Salomon, a business with problems over which he had essentially no control, had from the beginning put all that at risk.
He did not want to become interim chairman of Salomon. That way lay greater peril. If Salomon went down afterward, he would be even more closely associated with shame and disaster. But if there was anybody who could get himself and the other shareholders out of this mess, he was that person.
To do so he would have to extend the umbrella of his reputation, already at risk, even further to protect the firm. There was no way to avoid this challenge. Deryck Maughan and John Meriwether could not do it. He could not send Charlie Munger, or Tom Murphy, or Bill Ruane. He could not solve it by passing an idea along to Carol Loomis for an incisive article in Fortune. Even Big Susie could not solve this. For once, nobody could be his proxy. Only he could save Salomon. And if he walked away, the odds were high that Salomon would implode.
At eight o’clock on Saturday morning, August 17, he arrived to a surreal scene at Wachtell, Lipton’s offices. Gutfreund was not there; despite miserable weather he had decided to fly up to his Nantucket house, where Susan was staying. All the warlords—theoretically, candidates for CEO—had begun to gather outside an “interview room.” Only a few of them made sense or actually wanted the job, but he had to interview every one. Meanwhile, a pair of “plenty smart,” tough investigative lawyers from Wachtell, Lipton—Larry Pedowitz and Allen Martin—gave “a masterful presentation” to Buffett and Munger, who had flown in to participate in person. For the first time—to their outrage—they learned that the Treasury Department had investigated Mozer’s earlier trades.65
Next, Buffett had to make what he considered the most important hire of his life: to decide who would lead the firm. If he made a mistake, he could not reverse the decision later. Before starting the fifteen-minute interviews, he told the group, “J.M. is not coming back.”66
With that, he began to interview the candidates one by one. He asked them all the same question: Who should be the next CEO of Salomon?
“I was going into a foxhole with this guy, and he had to be the right choice. The question was, who would have all the qualities that would provide leadership to the firm, cause me not to worry for a second about whether anything was going on that was going to subsequently embarrass the firm or even put us out of business? As I talked to these people, what was really going through my mind was essentially the same questions that would go through your mind if you were deciding who you wanted to be a trustee under your will, or who you wanted to have marry your daughter. I wanted the kind of person who was going to be able to make decisions as to what should get to me and what could get solved below the line—who would tell me all the bad news, because good news always takes care of itself in business. I wanted to hear every bit of bad news as soon as it happened, so we could do something about it. I wanted someone who was ethical, who wouldn’t stick a gun to my head later on knowing that I couldn’t fire him.”67
Buffett found that all but one of the other candidates thought it should be Deryck Maughan, who had returned three weeks earlier from running Salomon’s Asian operations.68 Maughan, forty-three years old, now headed the investment-banking group. He was not a trader, and he was English, not American. He had the least resemblance to Mozer or any of Salomon’s frat-house trading boys of anyone that could be found. He was viewed as both ethical and possessed of common sense. Thanks to Liar’s Poker, the public thought of Salomon as a place full of people who stuffed their faces with onion cheeseburgers for breakfast and dangled strippers’ panties from their trading screens.69 Salomon, after all, was the firm where, as Lewis had written, a vice chairman was more like a chairman of vice.70 Maughan, however, was the very portrait of a dignified, impeccably tailored Englishman. Since he had spent the past several years in Tokyo, the chance that he was tainted by the Treasury auction scandal was remote.
Of all Maughan’s qualifications, possibly the most valuable was his distance from the crime. Within Salomon, land of the long knives, all of the other candidates had enemies. Maughan was a question mark, like the token black guy in the movie Putney Swope, who gets elected to the job of CEO of a backstabbing advertising agency when the old CEO croaks during a boardroom meeting. The other executives try to sabotage one another’s chances of getting his job by voting for Putney Swope, who ends up being elected by a huge majority.71 Maughan was respected, but no one knew him all that well. As one of the other warlords put it, they all voted for Maughan because it’s “better to choose someone you don’t know than someone you think is bad.”
In the movie, Putney Swope had had the sense to vote for himself. When Buffett asked Maughan who should run Salomon, Maughan replied adroitly: “I’m afraid you’re going to find out that it’s me.”72
Two other things got Buffett’s attention. Maughan did not ask him for protection against being sued. And Buffett—who, as much as he hated admitting it, did not enjoy paying people—was mightily impressed that Maughan did not ask how much the job would pay.
Maughan and two others were told to come to the office for the board meeting the next day. That afternoon, Buffett taxied back uptown to Graham’s UN Plaza apartment, where the arb boys met him to plead “with passion and logic” for Meriwether’s job. If J.M. left, Buffett knew, there was a risk that the arb boys would eventually join him.73 Without Meriwether, the main source of Salomon’s profits would drain away. Buffett’s investment in Salomon could become worth far less. Then Meriwether himself arrived, shaken. He did not want to resign, and he talked to Buffett at length. Buffett began to waver. He focused on Meriwether’s straightforwardness in reporting the problem.
“After listening to all of this, my reaction was not to ask for his resignation. As best I knew at the time, and this is still my belief, when he had heard of his subordinate’s misdeeds, he had gone straight upstairs to his superiors and the general counsel and had reported it. It seemed to me that it was the job of his superiors and the general counsel of the firm to then take action. No one, at this point, was suggesting that the general counsel should resign.”
Then Gutfreund called. His flight to Nantucket had been thwarted by Hurricane Bob and he was headed back to New York. “I have no future,” he said, agitated.74 They made plans to go to dinner. Gutfreund insisted that first they talk to his newly hired lawyer, Philip Howard, about severance pay.
Buffett and Munger called Howard, with Munger doing most of the talking. Gutfreund felt the firm owed him $35 million.
“As he was laying all this out, I was listening like the Japanese, saying, ‘Yes, I understand your position.’ Not ‘Yes, I agree with you.’ We had no interest whatsoever in trying to arrange a compensation agreement with anyone who was in the middle of a scandal of this proportion without knowing the full facts.”
Buffett then said that they could not agree upon an overall number, because no matter what the figure was, “Salomon Gives $XX Severance Package to Gutfreund” would “be the headline,” rather than the break with former management.75 They laid on praise of Gutfreund’s character, however; they told Howard that Gutfreund would be treated fairly, that they had the power to make it happen and had never broken a promise before. Buffett said, “The only way this won’t happen is if both Charlie and I die.” He later explained that this was a way of avoiding confrontation; that is, “deflecting Mr. Howard and getting him off this kick” because it would be a “little abrupt” to say they didn’t want to reach a settlement because “we don’t know the full facts” yet.
Buffett and Munger then went out for a steak with Gutfreund at Christ Cella. Gutfreund offered to stay on as a consultant at no charge in the days ahead. “I’m going to need all the help I can get,” Buffett said fervently. They talked about the problems of the firm, and Gutfreund said he thought Deryck Maughan was the right guy to run Salomon.
At one point, however, Gutfreund—who still knew a number of facts of which Buffett was not yet aware—said something that contradicted the warm and cozy scene of a few minutes before. “You guys are smarter than I am,” he told them. “You guys are going to fuck me.”76
It was with relief that Buffett and Munger escaped and went back to Kay Graham’s apartment. A large suite filled with Asian art, it had many happy associations for Buffett. He, Carol Loomis, and George Gillespie often got together there for a bridge game, ordering in deli sandwiches on the side. But he was not having nearly as much fun tonight.
Almost as soon as they arrived, Philip Howard showed up, carrying a sheaf of papers about Gutfreund’s severance, which he wanted Munger to sign.77 He talked to both of them for a while, until Buffett left them alone and went off to make some phone calls. Munger started getting irritable. They discussed the matter for perhaps an hour or more.
Munger had already made up his mind that he was going to say no to this deal. As he recalled later, “I was deliberately not listening. I was being polite, but I wasn’t paying much attention.… I sort of turned off my mind.… I was just sitting there politely with my head turned off.”
When Howard reached the end of his lengthy list of demands, Munger refused to sign the papers, but stressed that Gutfreund would eventually be treated fairly.78 On the way out the door, Howard hesitated. It bothered him that he still had nothing in writing. “You can’t get paid after the divorce,” he said. Munger reassured him: “Phil, you have to practice law the way my father did, by trusting in a man’s word.”79
While Howard and Munger were talking, Meriwether and his lawyer, Ted Levine, arrived. Meriwether had changed his mind. He said that he was in an impossible position and had to leave Salomon.
He “at least partially understood the seriousness of the company’s situation. He was pacing back and forth, and he was smoking cigarettes as fast as he could light them. He said that the best thing for him to do was to resign.”
Munger would later express feelings of guilt over agreeing to put Meriwether’s name in the press release, which he viewed as a mistake he had made under pressure.80 Both he and Buffett thought Meriwether could stay and fight it out, but they accepted his resignation.
“We talked for a considerable length of time. They stayed until midnight.”
Finally, it was just Buffett and Munger. Buffett went to bed, feeling that matters were, if not under control, at least starting to be straightened out.
The next day, Sunday, August 18, no one would rest.
Early in the morning, Buffett, Gutfreund, and Strauss met in one of the many conference rooms on the forty-fifth floor of Salomon’s office downtown before the meeting at which the board would ratify Buffett’s role as interim chairman. Suddenly, a lawyer appeared, waving a message from the Treasury Department. It was going to announce in a few minutes that Salomon was barred from bidding at Treasury auctions, both for customers and for its own account. All of them understood that in minutes, Salomon would be shot in the head. “We immediately saw that this would put us out of business—not because of the economic loss, but because the message that would go out to the rest of the world in headlines in the papers on Monday would be ‘Treasury to Salomon: Drop Dead.’ In effect, the response to installation of new management and banishment of the old would be an extraordinary censure delivered at an equally extraordinary time exactly coincident with the first actions of the new management.”
Buffett went off to another conference room to call the Treasury, seeking a stay of execution. The phone was busy. He got the phone company to agree to interrupt the call. They called back and said it was not a working phone. After many minutes of confusion, problems, and delays, Buffett finally spoke to someone in the Treasury Department. It was too late, he was told; the announcement had already gone out. The world now knew that Salomon was banned from doing business with the government.
Many of the board members were seeing their net worth evaporate in front of their eyes. Another slew of lawsuits, on top of those they already anticipated, would arrive on Salomon’s doorstep. Buffett appeared calm but determined. He had come to a realization. Gutfreund was being drummed out for having created a nightmare. Now he, Warren Buffett, was actually on the brink—not of overseeing the salvation of a business—but of steering a zombie Salomon through the night of the living dead. Buffett balked.
He said to the board that he was going to tell Treasury Secretary Brady he would not serve as interim chairman; he had come to save the firm, not to oversee its dismemberment. His reputation would be shot either way, he thought, and the fallout from resigning would be less than the grief from staying on. The board understood and agreed. It was the only card that Buffett had to play with Brady. Meanwhile, the board decided to pursue two other courses simultaneously. Buffett turned to Marty Lipton. “Do you know a bankruptcy lawyer?” he asked. Everyone sat frozen for a split second. Then Feuerstein and Lipton began to set in motion the wheels of filing for bankruptcy. If necessary, the firm would fail in an orderly manner, rather than a rout.
Four and a half hours remained to try to reverse the Treasury’s decision before a press conference that Salomon had already called for two-thirty p.m. to announce that Buffett would officially become interim chairman. Less than seven hours remained until the Japanese markets would begin to open for the week’s business, and London seven hours after that. When Tokyo opened, the landslide would begin.81 Lenders would start pulling their credits immediately. To plead for clemency had become immeasurably harder. They had not only to change the Treasury’s mind but to convince it to reverse itself in public.
John Macfarlane, Salomon’s treasurer, came in wearing a warm-up suit, directly from competing in a triathlon. He talked to the board about what the Treasury’s action meant to the firm.82 Banks had already started notifying Salomon they were pulling the firm’s commercial paper lines. Solly was careening toward what would almost certainly be the largest failure of a financial firm in history. If the government withdrew its endorsement of Salomon and the firm lost its funding, it would have to liquidate assets at fire-sale prices. That would be followed by severe consequences in the world markets, as some of Salomon’s creditors and counterparties, themselves unpaid, also began to fail. It was all going down the tubes. Buffett feared the regulators were going to regret their uncompromising stance.
“We were going to find a judge someplace in Manhattan, walk in on him while he’s watching baseball probably and eating popcorn at two in the afternoon, and tell him, we’re handing you the keys. You’re running the place now. By the way, what do you know about Japanese law, because we owe ten or twelve billion dollars in Japan? We owe ten or twelve billion in Europe. London will open at two in the morning. And as of this very moment, you’re running the place.”
Corrigan was hard to reach. Asking to speak directly to Treasury Secretary Nick Brady, Buffett found that he was not available either.
Brady was the patrician former CEO of brokerage firm Dillon, Read & Co., and Malcolm Chace Jr.’s nephew, thus a member of the family that had sold Berkshire Fine Spinning to Hathaway Manufacturing. He had written his college thesis on Berkshire, which depressed him so much that he had decided to sell his stock. Through Malcolm Chace, Buffett had once gone to visit Brady at Dillon, Read. The two weren’t close friends, but they had a “fine feeling about each other,” Buffett says. There was no particular reason, however, why the blue-blooded Brady, who hailed from the old-line firm Dillon, Read, would have a fine feeling about a social parvenu like John Gutfreund—or a fine feeling about an arrogant upstart firm like Salomon.
Nonetheless, Brady called Buffett back. He expressed empathy but made it clear that reversing the decision was an enormous problem.
“They were going to look silly. And I felt they looked silly, too, but they would look a whole lot sillier a few days later when financial carnage was spread from this act.”83
Brady said he thought Buffett was overreacting but agreed to call back again. He needed to consult with SEC Chairman Breeden, with Corrigan, and with Federal Reserve Chairman Alan Greenspan.
Buffett sat and waited for Brady’s call. The phone system on the conference floor didn’t ring on Sundays. To keep from missing an incoming call, someone had to stare continually at the phone to see whether a little green light lit up. For a while, Buffett stared at the phone, “as depressed as I have ever been.” Finally, someone enlisted a hastily-called-in secretary to stare at the light.
Behind the scenes, the regulators were talking. Corrigan had contacted Paul Volcker, former chairman of the Federal Reserve Board and now chairman at a prestigious investment-banking firm. Volcker, like Breeden, was incensed at Salomon. None of the regulators believed that Buffett would walk; they felt he had too much money and reputation at stake. They knew the decision would have an adverse impact on Salomon and they thought that was appropriate. They didn’t believe that Salomon would fail even if the Treasury pulled its imprimatur. The markets had so much confidence in Buffett that they assumed that simply by standing over Salomon holding his umbrella, he could save the firm. But they could not be certain of that. They considered whether the financial markets could survive a meltdown of one of its largest firms. The Federal Reserve would have to pump huge sums of money into the market to keep other banks afloat after Salomon failed to pay them. No rescue on this order of magnitude had ever been attempted. They were well aware of the likely second-order effects. The global financial market could potentially collapse. Did they think the Federal Reserve could handle it? “I was always an optimist,” Corrigan says. “I always said to myself, ‘You do what you have to do.’ ”84
Hours passed while Buffett waited for the phone to ring. Alan Greenspan called once, saying, no matter what, he wanted Buffett to stay. “It was a plea to just sort of stand there at the bridge regardless of what happened.”
Little by little, the trading floor began to fill with people, as if summoned by some invisible jungle drum. They lit their cigarettes and their cigars, sat around The Room, and waited. The arbs huddled, mourning Meriwether. Nobody knew what was going on upstairs. Slowly, the clock ticked toward the hour when trading would begin in Tokyo, sounding the firm’s death knell.
Upstairs, the board milled around uselessly, waiting while the regulators talked. Brady called Buffett back periodically but had nothing meaningful to say. Several times Buffett repeated his case in the gravelly voice that always betrayed him when under stress. He told Brady that Salomon’s attorneys were working on a bankruptcy filing. He invoked Salomon’s importance to the markets. He told Brady of the domino effect that the firm’s failure could cause.
“I said to Nick, I’d talked to Jerry Corrigan. This thing was going to implode. Tokyo was going to open, and we weren’t going to buy back our paper. It was over. Hour after hour, from ten o’clock, I kept telling the consequences of all these things, and it didn’t mean anything to him.”
Brady went back to his fellow regulators and talked. Most of them felt that this was special pleading. Buffett was asking for some kind of gold-star treatment for Salomon, and the firm did not deserve it.85
Salomon’s board couldn’t understand why Buffett’s arguments weren’t getting through to the regulators. They ran the financial markets. Why wasn’t it obvious to them that Salomon was going down?
As the afternoon wore on, Buffett’s logic failed, on this most critical occasion, to win over a key ally.
He had only one choice left. Of all avenues open to him, of all resources on which he could draw, this one was the most precious, the huge pool of crystal essence that he was most reluctant to tap. Buffett would undertake almost any item from his short list of most-loathed tasks—get into an angry, critical confrontation; fire someone; cut off a long friendship carefully cultivated; eat Japanese food; give away a vast sum of money; almost anything—rather than make a withdrawal from the Bank of Reputation. For all these many decades, he had brooded over, nurtured, cultivated, and stored that priceless commodity in its vault. Never had he withdrawn so much as a drop except when the odds hugely favored getting back even more in return.
Now the debacle at Salomon had exposed him utterly, putting the entirety at stake. And the only remaining hope was to ask, to literally beg as a personal favor, drawn purely on his own credibility, for help.
He would be putting himself eternally in Brady’s debt. He was staking his entire reputation—the reputation that takes a lifetime to build and five minutes to lose—on whatever happened afterward.86 He had to summon more courage than he knew he had.
Buffett’s voice cracked. “Nick,” he said, anguished, “this is the most important day of my life.”
Brady had his own problems to deal with. He didn’t think Buffett’s arguments were any good. But he heard the feelings behind the words. He could hear in Buffett’s voice that the man thought Salomon had thrown him over Niagara Falls in a barrel.
“Don’t worry, Warren,” Brady finally said. “We’ll get through this,” He hung up the phone and went off to consult.
But as the clock crawled toward two-thirty p.m., when the press conference was scheduled to begin, Brady had not called back.
Buffett decided to play the one card he could use with Corrigan. He picked up a phone. “Jerry,” he said, “I haven’t taken the job yet as interim chairman. We did not hold our meeting this morning because of what the Treasury did. So I am not the chairman of Salomon now. I could become the chairman in thirty seconds, but I am not going to spend the rest of my life shepherding the greatest financial disaster in history. I’m going to get sued either way by fifty people, but I don’t want to spend my life trying to mop up a total disaster on Wall Street. However, I don’t mind spending some of my life trying to save this damned place.”
Corrigan took Buffett’s threat to leave more seriously than the other regulators had, however. “I’ll call you back,” he said.
Buffett sat and waited, envisioning his next move. He pictured himself getting on an elevator, riding down six floors, walking onto the stage at the press conference all alone, and opening with the words “We’ve just declared bankruptcy.”
Downstairs, in the August heat, more than a hundred reporters and photographers who had been pulled away unexpectedly from their baseball games and swimming pools and family picnics swarmed into Salomon’s auditorium for the press conference. The only thing they had to fill their interrupted Sunday afternoon was the sight of Salomon’s blood-drenched gladiators, gutted before their eyes on the sand of the Colosseum.
As the minutes passed, a white and shaken Meriwether arrived. He had gone, as instructed, to see Dick Breeden, chairman of the SEC, asking for help. Meriwether reported that Breeden had turned them down flat. Twice in the conversation, Breeden had said Salomon was “rotten to the core.”
“Rotten to the core,” Meriwether repeated in shock, “rotten to the core.” All of them suddenly realized that the Treasury’s move had been a joint decision among the Federal Reserve, the Treasury, and the SEC, their condemnation a sudden reversal of the world’s opinion of Salomon, a dramatic payback for years of pride and arrogance.
The hour of the press conference came and went, while the reporters fidgeted and grew more irritable downstairs. Brady did not call. The phone sat unblinking.
Finally, Jerome Powell, assistant secretary of the Treasury, called. The Treasury would not fully reverse itself, he said. Salomon could not bid in Treasury auctions for customers. Yet it would compromise on Salomon’s most important point: The firm could bid for its own accounts.
“I think it will,” Buffett said.
He loped back into the boardroom and told them. The room erupted with relief and joy. As rapidly as he could talk, Buffett oversaw the election of himself as interim chairman and Deryck Maughan as director and operating head of Salomon Brothers. At about a quarter to three, he walked outside and had somebody call downstairs to the trading floor.
Maughan was sitting with the traders, watching the clock. At a nearby desk, John Macfarlane’s team was working on a contingency plan to dump the firm’s assets in Japan as fast as they could work the phones. Somebody called from upstairs and told Maughan to meet Buffett at the elevator bank for a talk. Maughan was uncertain whether he was about to be made the boss—or told he had a new one. He walked over to the elevator. The door opened, and he saw Buffett standing inside. “You’ve been tagged,” Buffett said, and motioned for Maughan to get in. Instead of riding back up to the boardroom, they descended two more floors into the jaws of the waiting press.87
“The press was unruly. They were like animals. Every question was a trick question. It was a big story, and they wouldn’t have minded if it had gotten bigger. It was their chance to shine. The TV people were particularly obnoxious. They wanted us to hurry up for the five o’clock news, or the six o’ clock news, and I wouldn’t cooperate with them. And I could just feel it. I could just tell it. I had to fall on my face. I had to be found a phony. They wanted it to develop that way. There were all kinds of book contracts floating around that room, but only if somehow Salomon failed.”
Sitting on the dais, Buffett crossed his arms; he looked weary. Maughan, his light brown hair brushed into a neat pouf, stared wide-eyed at the crowd like the proverbial deer caught in the headlights. Both were clad in navy suits, white shirts, and funereal ties. “I had no preparation, zero,” Maughan says. “ ‘You’re tagged’ was my complete set of instructions.” He did not know a single detail of what had transpired upstairs. They began.
What happened? the reporters wanted to know.
Buffett, suit jacket bunched up around his ears, explained: “The failure to report is, in my view, inexplicable and inexcusable. I have seen similar dumb things happen in other operations that I am more intimately involved in but not with such consequences.”
Had the culture contributed to the scandal? “I don’t think the same thing would have happened in a monastery,” Buffett said.
Somebody asked him what he would get paid. “I’m going to do this for a dollar,” he said. The board, sitting in the audience, was dumbfounded. This was the first they had heard of it.
The reporters declined to be soothed. Were records altered? Who altered them? Was there a cover-up? Who participated in the cover-up?
Yes, some records had been altered. There had been something resembling a cover-up. At that, the pack grew excited, throwing questions hard and fast. Here, perhaps, was the stumbling prey they were hunting, close to capture, ready to be torn apart by their sharp teeth. Alas, the trail grew cold when the cover-up included no one significant beyond those who had already been sacked.
Someone came out to the stage and told Buffett he had a phone call from the Treasury. He hurried from the dais, leaving Maughan, astonished, twisting in the wind alone. Nevertheless, Maughan managed to answer some questions in the perfectly articulated monotones of a BBC announcer narrating a documentary about the mating habits of the wildebeest.
Buffett returned with a press release from the Treasury Department, announcing that Salomon had part of its credibility back. The journalists were not mollified. They pressed on.
After well over an hour, one of the directors who was sitting next to Munger nudged him and said, “Isn’t Warren ever going to end this thing?”
“Maybe he doesn’t really want to,” Munger said. “Warren knows what he’s doing.”88
How much did the phony trades cost the government? How many customers had told Salomon they wouldn’t do business with the firm? What severance would be paid to the ex-executives? Why didn’t Wachtell, Lipton take the situation more seriously? What were the details of the strange fraudulent trade the investigators had discovered, the one referred to in the press release as the “billion-dollar practical joke”?
“It is not a joke. I suppose if you had to characterize it in some way—” began Buffett.
“Those were your words in the release,” retorted the reporter, sharply.
“Those were not my words. It was in the release. My name is not on the bottom of the release. You can characterize it as a bizarre incident. My definition of a practical joke is one you can laugh at after hearing it. I don’t see it as the least bit funny.”
The reporters, most of whom had read Liar’s Poker, waited for an explanation. Salomon, they knew, was famous for its “goofs.” Traders were constantly stealing the clothes out of each other’s suitcases and replacing them with wet paper towels or lacy pink panties. The most famous goof at Salomon concerned the game of liar’s poker itself, which Gutfreund once allegedly offered to play Meriwether for a million dollars on a single bet, no tears. Meriwether supposedly countered with ten million, causing Gutfreund to stand down. While even this story was thought to be a sort of goof, containing apocryphal elements, until now ten million dollars was the outside limit that anyone had ever imagined for a Salomon goof.
But for a billion dollars, you could fill New York Harbor with rubber chickens as high as the Statue of Liberty’s thighs. What, then, could have been the “billion-dollar practical joke”?
“Apparently a woman was leaving the department after many, many years—retiring, I guess,” Buffett said. “An order was worked out with somebody, to give her a very large order. A billion dollars. A billion-dollar order on a new offering of thirty-year Treasury bonds. Then—and this gets vague—I guess the plan was to maybe convince her somehow that the order was not submitted and have the client question the fact that it was not submitted. It was to try to scare the hell out of her or something. I don’t know.
“The bid actually did get submitted.”
A hundred fifty reporters sat in silence. Salomon had bought a billion dollars’ worth of bonds in a practical joke gone wrong. Buffett was not kidding that the culture of Salomon was going to have to change.
“It should have been crossed out. My guess is that whoever did it did intend to cross it out. It has to be the dumbest joke ever attempted to be perpetrated.”
No one said a word.
Maughan: “Any more questions?”
The hot air had been let out of the room. After this bit of truth-telling, what could anyone ask? Only a few more mild questions followed.
The press conference ended. Buffett looked at his watch as they walked off the stage. “I’ve got to get back to Omaha,” he said.
“Warren, what’s happening here?” asked Maughan. He had never spoken to any of the angry government officials, had never attended a Salomon board meeting, and the ship was sinking. “Do you have any views on who should form the management? Is there any direction you want to give me as a strategy?”
“If you have to ask me questions like that, I picked the wrong guy,” Buffett said. He walked away without another word, leaving his $700 million and his reputation in the hands of a man he had met thirty hours before.89
On Monday morning, Maughan went out to The Room to shore up the staff’s devastated morale. He took off his jacket and rolled up his sleeves. The firm, he said, had faced three tests. The first was character. By firing Mozer and his number two, Thomas Murphy, and accepting the others’ resignations, the firm had passed that test.
The second was confidence. By regaining at least partially the Treasury Department’s good graces, Salomon had passed that test.
The third was will. “This is not the same firm,” said Maughan, “but we must keep aspects of the old culture while we bring in a new one.”90
Some of the traders stirred uneasily. What did that mean, a new culture?
But at least Salomon had gotten one lucky break. Overnight, news had flashed over the wire that Soviet Premier Mikhail Gorbachev had been ousted in a coup. The stock market immediately dropped 107 points. Business coverage, which had been drilling on Salomon all day Friday, suddenly shifted focus as the world turned its attention toward Gorbachev, held under house arrest by eight of his own military and state officials. With tanks rolling into Moscow, customers got on the phones, and the bond desk did a brisk business that morning.
“There are lots of ways of getting off the front page,” said a salesman, “but sending in the Red Army has got to be the most creative.”91