Through the bridge, through Ireland, through China, as late as 1994, Buffett devoted every day to looking for stock to buy for Berkshire Hathaway. But it was growing steadily more difficult to find a wonderful business at a fair price. He was still putting money into Coca-Cola, until he had spent a total of $1.3 billion. He bought another shoe company, Dexter. Here he was a little outside his “circle of competence,” making a bet that demand for imported shoes would wane.1 Buffett was also buying American Express stock again.
He wanted the rest of GEICO.
Buffett negotiated furiously with Sam Butler, GEICO’s chairman, and its new CEO, Tony Nicely, to buy the fifty-two percent of GEICO that Berkshire didn’t already own. In the end, he wanted GEICO so badly that he paid $2.3 billion in stock. Despite having fought so hard, Buffett actually regarded the price as reasonable, considering that he’d gotten the first forty-eight percent for only $46 million.
The GEICO deal marked a turning point. The stock market was on a tear, with new technology offerings unexpectedly popular in 1994.2 Buffett’s knowledge of technology was spotty. Despite his sense of the Internet’s importance, honed during his friendship with Bill Gates and his many games of bridge, it had not yet occurred to Buffett to tell GEICO to hurry up and exploit the Internet to sell insurance. To Buffett, computers were just tunnels that enabled him to reach other people who could play bridge. As investments, he still considered technology stocks risky bets.
Even had he been of the temperament to do so, Buffett didn’t need to make risky bets. Decisions made years ago were still compounding for him. The hiring of Ajit Jain had meant that when Hurricane Andrew blew South Florida off the map in 1992, Buffett was able to start a new business, “catastrophe reinsurance,” which charged a premium price to stand by as insurer of the unthinkable. Then the Northridge earthquake hit. Almost no one else had the capital to put up billions on a risk like that. But Berkshire Hathaway did.
The old days of scouring the Moody’s Manuals for teensy companies were long gone. Most of the ideas for buying whole companies were now brought to him.
Some may have thought, If he’ll buy Dexter Shoe, Buffett will buy anything. He was starting to regret that deal. Dexter was getting killed by foreign competition; people had not lost their interest in buying imported shoes. But the mistakes were few and the home runs many: Cap Cities/ABC negotiated a deal to sell itself to Disney for $19 billion, and Berkshire made $2 billion, almost four times its original investment. Tom Murphy went on the board of Disney, and Buffett became linked to Disney through Murphy. At Sun Valley, the Buffetts now mingled easily with a crowd that ranged from Coca-Cola executives to movie stars. He also went back on the board of the Washington Post, which was now being run by Don Graham, one of his favorite people, enabling him to rejoin his favorite company in his favorite milieu—newspapers.
In early 1996, Berkshire stock suddenly rocketed to $34,000 a share, valuing Berkshire as a company at $41 billion. An original partner who invested $1,000 in 1957 and left it untouched would now have $12 million stashed away—double the amount of just a couple of years before. Buffett himself was worth $16 billion. Susie now had $1.5 billion worth of Berkshire stock—which she had promised not to touch.3 Both she and Charlie Munger were now on the Forbes 400 list—as billionaires. Once invisible, Berkshire was noticed by people who had never heard of it before. That year, five thousand people from all fifty states came to the shareholder meeting–cum–discount mall.
Now it cost so much to buy a share of BRK that copycats set up investment trusts. Their idea was to mimic Berkshire Hathaway’s stock portfolio and let people buy in smaller units, as if it were a mutual fund. But Berkshire was not a mutual fund; it was a perpetual-motion vacuum cleaner that sucked up businesses and stocks and spit out cash to buy more businesses and stocks. That couldn’t be replicated by buying the stocks it owned. Among other things, you didn’t get Buffett.
Moreover, the copycat funds were buying the stocks that Berkshire owned at prices far higher than Berkshire had paid, and charging fat fees to do it. They were cheating investors. Now the cop in Buffett came out. To foil the putative copycats, he decided to issue a new class of shares. Each B share—or “Baby B”—was equal to 3.33 percent, or 1/30, of a pricy A share.
He had great fun with the B shares, writing: “Neither Mr. Buffett nor Mr. Munger would currently buy Berkshire shares at that price, nor would they recommend that their families or friends do so.”4
He decided to sell an unlimited amount of stock to ensure that the price would not rise because of more demand than supply.
The inverted logic of selling stock that you wouldn’t buy yourself, and explicitly saying so, pleased Buffett enormously. Moreover, issuing the B shares fulfilled a duty to his shareholder “partners.” All that cash pouring in from the B shares would be a pretty good deal for them.
No CEO had ever done such a thing before. A small forest of trees was felled in media coverage of Buffett’s honesty. Yet investors gobbled up the B shares anyway. Buffett thought them foolish and said so privately and often. Yet there was no denying it was enormously flattering that they did, for they were clearly buying only because of him. He would have been secretly disappointed had the B share offering been a flop. The B shares were a Buffett no-risk deal: His shareholders won, and Buffett won, no matter how the offering turned out.
The Baby Bs forever changed the character of Buffett’s “club.” After May 1996, forty thousand new owners could call themselves shareholders. At the next meeting, 7,500 people showed up and spent $5 million at the Nebraska Furniture Mart. The meeting turned into Woodstock for Capitalists. In 1998, ten thousand people came. Yet as the money and the people and the fame came rolling in, an underlying shift took place in the world in which Buffett worked that would have profound effects on him and everybody else.
There really was no such thing as “Wall Street” anymore. Now financial markets were a string of blinking terminals connected by computers hooked up to the Internet that reached every corner of the world. A guy named Mike Bloomberg, whom Salomon had been dumb enough to fire back in the eighties, had created a special computer that captured every piece of financial information that anyone could possibly want. It made graphs, it made tables, it did calculations, it gave news, it gave quotes; it could do historic comparisons and set up competitions between companies and bonds and currencies and commodities and industries for whoever was lucky enough to have a Bloomberg terminal on his or her desk.
By the early 1990s, the Bloomberg terminal was becoming ubiquitous. The Bloomberg saleswoman had called Berkshire Hathaway for three years in a row. “Nope” was the answer every time. Buffett felt that following the market minute to minute by computer was not the way to invest. Finally it became obvious even to Buffett that to trade bonds you had to have a Bloomberg terminal. But the Bloomberg sat some distance from Buffett’s office and he never looked at it; that was the job of Mark Millard, the bond trader.5
The advent of the Bloomberg terminal mirrored the ongoing struggle over Salomon’s identity, which continued within the firm. Its laggard businesses had never gotten back on their feet. In 1994, Maughan had tried to realign pay at Salomon on the theory that employees should suffer with the shareholders when times were bad. There were people inside the firm who agreed with him.6 But that was not the standard anywhere else on Wall Street, so thirty-five senior people walked out the door. Buffett was disgusted with the employees’ unwillingness to share the risk.
Deprived of Meriwether to bonus-pimp for them, the arbs fought for their share. Buffett was willing to pay them for results—the firm still made most of its money from arbitrage—but increasing competition made it harder for them to produce.
Arbitrageurs make a bet that a temporary gap of prices between similar or related assets will eventually tighten. For example, the bet may be whether two nearly identical bonds will trade at a closer price.7 With so much new competition, the easy trades had become scarcer. In response, the arbs took larger positions with more risk, often using debt to finance their bets.
The rules of the racetrack said not to do so. The reason is the math of losing money, which works like this: If someone has a dollar and she loses fifty cents, she has to double her money to make back what she’s lost. That’s difficult to do. It is tempting to borrow another fifty cents for the next bet. That way you only have to make fifty percent (plus the interest you owe on the loan) to get back whole—much easier to do. But borrowing the money doubles your risk. If you lose fifty percent again, you’re history. The loss has wiped out all your capital. Hence Buffett’s sayings: Rule number one, don’t lose money. Rule number two, don’t forget rule number one. Rule number three, don’t go into debt.
The arbs’ strategy, however, assumed that their estimate of value was right. Therefore, when the market moved against them, they only had to wait to make the money back. But “risk” defined this way—in terms of volatility—presumes the investor can be patient and wait. Anyone who borrows to invest may not have that luxury of time. Moreover, to enlarge a losing trade required extra capital stashed somewhere that could be forked over on a moment’s notice if the need arose.
Larry Hilibrand lost $400 million—an enormous sum—arbitraging the difference in interest rates on mortgage-backed bonds. He was convinced that he could make back the loss on the mortgage arbitrage if the firm would double his bet. Buffett agreed with Hilibrand in this instance and gave him the money for the trade—which in fact reversed to become profitable.
What the arbs really wanted, however, was J.M. During Salomon’s recovery, Meriwether waited on the sidelines at first while the arbs begged to bring him back. While Deryck Maughan made polite noises, everybody knew he did not want Meriwether. Nevertheless, Buffett and Munger had given a thumbs-up, with some conditions. Meriwether could return to his old position but would have to report to Maughan, with less freedom to run his operation. Unwilling to work under a shorter leash, Meriwether had broken off negotiations and in 1994 went off to found his own hedge fund, Long-Term Capital Management. It would operate the same way as the bond arbitrage unit at Salomon, except that Meriwether and his partners got to keep the profits.
One by one, Meriwether’s key lieutenants left Salomon to join him at the new harbor-front offices of Long-Term Capital Management in Greenwich, Connecticut. Deprived of his biggest moneymakers, Deryck Maughan saw the “for sale” sign heading for Buffett’s block of stock and began planning for the day when Buffett would wash his hands of Salomon.8
In his 1996 shareholder letter, Buffett said that “virtually all stocks” were overvalued. Whenever the market ran hot it was because Wall Street was in vogue. That year, Maughan thought it timely to pitch the restaurant in front of Salomon’s casino to Sandy Weill, CEO of Travelers Insurance, as the anchor tenant in a global financial shopping mall that could compete with Merrill Lynch. Weill supposedly still resented Buffett for the sweet deal Berkshire got after Weill’s squeeze-out in the Fireman’s Fund sale more than a decade earlier. He distrusted the arbitrage casino, but he saw an opportunity for the restaurant chain on a global scale. When he bought Salomon for Travelers, some observers felt that since Solly hadn’t done well under Buffett, Weill saw it as a chance to beat Buffett at his own game. Buffett hailed Weill for the decision as a genius at building shareholder value.9 And Travelers paid $9 billion for Salomon, bailing Buffett out of his problem-child investment.10
Meriwether, who knew that Buffett liked owning casinos, had gone to Omaha with one of his partners to try to raise money for Long-Term Capital for its February 1994 launch. They ate the now-obligatory dinner at Gorat’s, where J.M. pulled out a schedule over his steak to show Buffett different probabilities of results and how much money Long-Term could make or lose. The strategy involved earning tiny profits on many thousands of trades, leveraged by at least twenty-five times the firm’s capital. The highest loss that Long-Term contemplated was twenty percent of its assets, the odds of which it estimated at no more than one in a hundred.11 Nobody estimated the odds of losses bigger than that; the numbers wouldn’t make sense.
The name Long-Term came from the fact that investors were locked in. Meriwether knew that if he started losing money, he needed the investors to stay until the losses turned around. But so much leverage, combined with no way to cap the risk completely, made Buffett and Munger uncomfortable.
“We thought they were very smart people,” says Munger. “But we were a little leery of the complexity and leverage. We were very leery of being used as a sales lead. We knew others would follow if we got in.” Munger thought Long-Term wanted Berkshire as a “Judas goat.” “The Judas goat led the animals to slaughter in the stockyards,” he says, recalling Omaha. “The goat would live for fifteen years, and of course the animals that followed it would die every day as it betrayed them. Not that we didn’t admire the intellect of the people at Long-Term.”12
Long-Term charged its clients two cents off every dollar under management every year that they invested, plus a quarter of any profits it earned. Clients signed up for the prestige. It raised $1.25 billion, the largest hedge-fund start-up in history. The old arb team at Salomon now worked together in secrecy, with no outside interference and no more sharing of the profits with other parasitic Salomon departments. The fund smoked in its first three years, quadrupling its investors’ money. By the end of 1997, Long-Term had amassed $7 billion of capital. Then competition from start-up hedge funds depressed returns. Meriwether sent $2.3 billion of money back to investors; the rest was all the market could digest. The hedge fund in Greenwich was now running more than $129 billion in assets—and a like amount of debt—on only $4.7 billion of capital. In a near-instant replication of Buffett’s steady accumulation of wealth, through the magic of fees earned on borrowed money, nearly half of the capital belonged to the partners themselves.13 Despite the fifty-year-old Meriwether’s difficulty making eye contact, he and his firm had a swagger to match their brilliant reputations, and the partners took full advantage of the fund’s position to dictate terms to its clients, to the fifty-something banks from which it borrowed, and to its brokers (in many cases these parties were one and the same).
Beating Buffett’s record was now the goal of most money managers in worldwide finance. Some thought Meriwether had at least an unconscious grudge against Buffett for failing to protect him at Salomon, then subsequently not hiring him back.14 Unbeknownst to anyone, Long-Term Capital was shorting Berkshire Hathaway, on the theory that BRK was overpriced relative to the value of the stocks that it owned.15 Not only that, Long-Term set up a Bermuda reinsurance company, Osprey Re, named after the copper osprey that sank its talons into helpless prey in the fountain outside Long-Term’s building. Osprey Re was going to insure earthquakes, hurricanes, and similar natural disasters—it was, in other words, entering Ajit Jain catastrophe reinsurance territory. The ditches on the roadside of the insurance highway were filled with wreckage. Buffett had barely escaped himself once or twice in his younger days. Whenever a novice came along, better find the keys to the tow truck.
Gradually, as Long-Term’s coffers swelled and imitators followed for the next several years, through early summer of 1998, lenders collectively began to realize that, as periodically happens, they had gotten too euphoric about the prospects that all these people to whom they had lent money would pay them back. Long-Term’s competitors started dumping their dodgier positions as interest rates rose. That pushed down prices and set off a cycle of selling. But Long-Term had bet the opposite way, selling the safest assets and buying the riskiest, which were relatively cheaper. Its intricate models basically said that over time the financial markets were becoming more efficient, so the prices of risky assets would converge toward the prices of safer assets. Its biggest trades were a formulaic guess that the market would become less volatile, meaning that as the market bounced around, it would oscillate in smaller arcs. And historically that had been so. But as history had also shown, generally did not mean always. Long-Term knew that. It had made investors lock in their capital long enough to be safe—or so it thought.
On August 17, 1998, Russia suddenly defaulted on its ruble debt, meaning it would not pay its bills. Investors began dumping everything in sight. A money manager had warned Long-Term, early on, that its strategy of eking out teensy profits on a zillion trades was like “picking up nickels in front of a bulldozer.”16 Now—surprise—the bulldozer turned out to have a Ferrari engine, and it was racing toward them at eighty miles an hour.
On Sunday, August 23, “I was playing bridge on the computer. I picked up the phone, and it was Eric Rosenfeld at Long-Term.” Buffett liked Rosenfeld, who had once gotten a field promotion to head trader at Salomon. Now he had been deputized by Meriwether to cut back the portfolio’s size by selling the firm’s merger arbitrage positions. “I hadn’t heard from him for years. With fear in his voice, Eric started to talk about me taking out their whole big stock arbitrage position, six billion dollars’ worth. They thought stock arbitrage was mathematical.”17 Responding reflexively, Warren Buffetted Rosenfeld. “I just said to Eric, I would take certain ones but not all of them.”
By a few days later, the market’s gyrations had cost Long-Term half its capital. The partners had spent a week talking to everybody in their well-connected database, trying to raise money before they had to report this dire news to their investors on August 31. No dice. Now they agreed that Larry Hilibrand—the superrationalist whose sobriquet on Wall Street was still “the $23 million man,” for the outsize bonus that had set Mozer off on his tear—would make a pilgrimage to Omaha and reveal what Long-Term owned.
The next day the Dow dropped four percent in what the Wall Street Journal referred to as a “global margin call,” with investors panicking and selling. Buffett picked up Hilibrand at the airport and drove him back to Kiewit Plaza.
Hilibrand had gone deep into debt to pump up his personal investment in the firm, leveraging the leverage with which Long-Term had already leveraged itself. He spent the day going over every position the firm owned and stressing the incredible opportunity he was offering to Buffett.18 “He wanted me to put in capital. He described the seven or eight big fundamental positions. I knew what was happening with relationships and on prices in these areas. I was getting more interested as time went along, because they were crazy relationships and spreads. But he was proposing a deal to me that didn’t make any sense. They thought they had time to play the hand out. But I said no, so that was that.” Buffett told him, “I am not an investor in other people’s funds.”19 He was only interested as an owner.
Long-Term didn’t want an owner, only an investor. It came close to finding somebody else, but then he backed out.20 By month-end, when it had to report to its investors, the fund had lost $1.9 billion—almost half of its capital—through a historically unusual combination of stock-market declines and almost hysterical aversion to risk in the bond markets.21 Since the model had contemplated losses of twenty percent as being a one-in-one-hundred-year event—like a moderate West Coast earthquake—this was somewhat like a Category 4 hurricane hitting New York City. Meriwether wrote his investors a letter saying “The opportunity set in these trades at this time is believed to be among the best that LTCM has ever seen.… The Fund is offering you the opportunity to invest in the Fund on special terms related to LTCM fees.”22 Long-Term was behaving as though it could raise capital to wait out the crisis and profit from its turnaround. But with the kind of leverage it had taken on, it didn’t have that option. The firm’s insular culture and years of getting its way had blinded the partners to the reality that no investor would put in money to save it without also taking control.
The day he read this, Buffett wrote a letter to a colleague and forwarded Meriwether’s entreaty, saying:
Attached is an extraordinary example of what happens when you get 1) a dozen people with an average IQ of 160; 2) working in a field in which they collectively have 250 years of experience; 3) operating with a huge percentage of their net worth in the business; 4) employing a ton of leverage.23
Anything times zero is zero, Buffett said. A total loss is a “zero.” No matter how small the likelihood of a total loss on any given day, if you kept betting and betting, the risk kept stacking up and multiplying. If you kept betting long enough, sooner or later, as long as a zero was not impossible, someday a zero was one hundred percent certain to show up.24 Long-Term, however, had not even tried to estimate the risk of a loss greater than twenty percent—much less a zero.
In September, Long-Term searched desperately for money, having now lost sixty percent of its capital. Other traders had started putting the squeeze on the fund, shorting positions they knew Long-Term owned because they knew Long-Term needed to sell, which would force prices lower. Investors were fleeing anything risky in favor of anything safe, to a point that Long-Term’s models had never considered possible because it made no economic sense to them. Long-Term hired Goldman Sachs, which came in as a partner to buy half the firm. It needed $4 billion, an almost unimaginable sum for a hedge fund in distress to raise.
Goldman Sachs got in touch with Buffett to see if he was interested in a bailout. He wasn’t. However, he would consider teaming with Goldman to buy the entire portfolio of assets and debt. Together they would be strong enough to wait the crisis out and trade the positions deftly for a profit. But Buffett had a condition: no Meriwether.
Long-Term owed money to a subsidiary of Berkshire. It owed money to people who owed money to Berkshire. It owed money to people who owed money to people who owed money to Berkshire. “Derivatives are like sex,” Buffett said. “It’s not who we’re sleeping with, it’s who they’re sleeping with that’s the problem.” As Buffett headed to Seattle that Friday to meet the Gateses and embark on a thirteen-day “Gold Rush” trip from Alaska to California, he called a manager and told him, “Accept no excuses from anyone who doesn’t post collateral or make a margin call. Accept no excuses.”25 He meant that if the Howie-equivalents out there paid the rent one day late, then seize their farms.
The next morning he, Susie, the Gateses, and three other couples flew to Juneau to helicopter over the ice fields. They cruised up the fjords to view huge blue icebergs and waterfalls cascading over three-thousand-foot cliffs. But as Buffett sat politely through a slide presentation on glaciology on board the ship that evening, his mind wandered to whether Goldman Sachs would be able to put together a bid for Long-Term. Predatory sellers had pushed prices so far down that Long-Term was a cigar butt. An opportunity to buy such a large bundle of distressed assets had never arisen so quickly in his career.
The next day, the Gates party went ashore at low tide to view the hundreds of brown grizzly bears that frequented Pack Creek. Jon Corzine, the head of Goldman Sachs, called Buffett on his satellite phone but kept being cut off. “The phone didn’t work because of these half-mile-high rock walls on either side of the boat. The captain would point out, Look, there’s a bear. I was saying, To hell with the bear. Let’s get back where I can hear the satellite phone.”
Two or three hours went by with Buffett held incommunicado as the party spent the afternoon crossing Frederick Sound so they could view the humpback whales. Corzine stewed in New York before he regained brief—and final—contact with Buffett. By the time Buffett resignedly trudged off to view a slide show on Alaskan marine wildlife that evening, Corzine had gathered that he could make a bid, as long as the investment had nothing to do with, and was not managed by, John Meriwether.
On Monday, Buffett remained out of touch and Corzine grew pessimistic about working out a bid. He had begun to talk with Peter Fisher at the Federal Reserve, who was drawing together Long-Term’s creditors to negotiate a joint bailout. Hope began to stir that the Fed would cut interest rates.
Long-Term lost another half billion dollars; the banks picking over its books were using what they learned against it.26 The fund now had less than a billion dollars of capital left. The irony was the $2.3 billion it had paid out to its own investors a year before in order to increase the share of the fund owned by its partners. If it had that money now, Long-Term might have been in a position to survive on its own. Instead, it had a hundred dollars of debt for every dollar of capital—a ratio no sane lender would ever entertain.
Buffett was en route to Bozeman, Montana, with the Gates party, but Corzine had reached him earlier that morning and gained permission to enlist a large insurer, AIG, which owned a derivatives business, to join the bid. Its chairman, Hank Greenberg, was on friendly terms with Buffett. AIG had the experience and the team to replace Meriwether as manager, and Greenberg’s powerful presence would balance out Buffett’s—and it might make Buffett’s bid more palatable to Meriwether.
The next morning, forty-five bankers arrived at the Fed, as summoned, to discuss a bailout of the customer that had bullied them so relentlessly for the past four years. Long-Term had them over a figurative barrel once again, for if it went down, other hedge funds would go down with it. As one domino fell after another, a global financial meltdown was a real possibility—a repeat of Salomon. This was the warning that Buffett and Munger had been repeating at their shareholder meetings since 1993. Some of the banks now feared for their survival unless they helped save the fund. They were reluctantly contemplating putting more money into Long-Term—money that would only go to pay Long-Term’s debts—on top of money they had already invested in the fund and lost. When Corzine told them Buffett was also bidding, the idea that he was going to come in and buy it to make a killing went down poorly, even though he would be bailing everybody out. Somehow, Buffett always won. People found it irksome. New York Federal Reserve Bank President William McDonough called Buffett to find out if he was serious. About to board a bus for Yellowstone National Park, Buffett told McDonough that, yes, indeed, he was ready to make a bid and could do so on short notice. He couldn’t see why the Federal Reserve would be orchestrating a bailout when Berkshire, AIG, and Goldman Sachs, a group of private buyers, stood ready to solve the whole problem without government assistance. He called Long-Term around eleven o’clock New York time on a crackly satellite phone to say he was going to bid through Goldman for the whole portfolio.
“I didn’t want to hold the bus up, so I went along. It was killing me.”
An hour later, Goldman faxed a single page to Meriwether offering to buy the fund for $250 million. As part of the deal, Meriwether and his partners would be fired. If Meriwether accepted, AIG, Berkshire, and Goldman would put another $3.75 billion into Long-Term, with Berkshire funding most of that. To minimize the chance of Long-Term shopping the bid to gin up a higher offer, Buffett had given them only an hour to decide.
By then, Long-Term had just over $500 million left, and Buffett was bidding just under half that. After paying off debt and losses, Meriwether and his partners would be wiped out, their nearly $2 billion of capital gone. But the document had been drafted by Goldman with a mistake in it. It offered to buy LTCM, the management company, instead of its assets, which Meriwether knew was what Buffett wanted. Meriwether’s lawyer said he needed his partners’ consent to sell the entire portfolio rather than the management company.27 Long-Term asked for a temporary emergency investment pending receipt of the approvals. But they couldn’t reach Buffett on his phone. If they’d reached him, he said later, he would have taken that deal. Buffett was dialing and redialing the satellite phone in Yellowstone, trying to call Corzine at Goldman and Hank Greenberg at AIG. The phone didn’t work. He had no idea what was going on back in New York.
In the room with the bankers, McDonough was in a quandary. He had an offer from the Berkshire-Goldman-AIG consortium but no deal. It was hard to justify government involvement in orchestrating a bailout when there was a viable private bid on the table. Finally, he told the assembled bankers that the other bid had failed for “structural reasons.” Buffett was not there to make a counterargument. The Federal Reserve brokered a deal in which fourteen banks put up a total of $3.6 billion. Only one bank, Bear Stearns, refused to participate, earning the long-lasting enmity of the rest. Meriwether’s crew negotiated an arrangement for themselves that they considered slightly better than “indentured servitude.”28
That night at the Lake Hotel, Buffett found out what had happened. He felt that Meriwether didn’t want to sell to him; otherwise, he would have found a way. Perhaps it had weighed on Meriwether’s mind that, as one of the fund’s partners said, “Buffett cares about one thing. His reputation. Because of the Salomon scandal he couldn’t be seen to be in business with J.M.”29 In the end, financially, the bailout was a much better deal than Buffett’s.
The next day, Buffett was still turning over in his mind whether there was some way to undo it. Gates had a treat in store. When they arrived in Livingston, Montana, in early afternoon to board a nine-car private train fitted out with burnished wood and polished leather that Gates had rented, Sharon Osberg was waiting along with Fred Gitelman, a low-key computer programmer and bridge player. Gates had flown them in. While everyone else was admiring the cliffs and waterfalls of the Wind River Canyon, the foursome retired to an upstairs lounge with a transparent dome for a twelve-hour bridge marathon. Periodically, Buffett’s phone rang and he talked with someone in New York about Long-Term as the spectacular scenery rolled past. It still might not be too late to unwind the impending bailout and resurrect a private deal. But it wasn’t working out.30 At least the bridge distracted him.
The next morning, after a final round of bridge, the train rolled to a halt and dropped Osberg and Gitelman off in Denver. Over the next few days, as the train wound its leisurely way to the Napa Valley via the Grand Canyon, Buffett read about the rescue in the newspapers and gradually lost hope of participating.
Only seven years after the regulators had contemplated letting Salomon fail—with all the consequences that that potentially entailed—the Federal Reserve had now engineered the bailout of a private investment firm, an unprecedented intervention in the market to avoid a similar event. Afterward, the Fed slashed interest rates three times in seven weeks to help keep the financial stumble from paralyzing the economy. It was by no means certain that any such paralysis would occur, but the stock market took off like a screaming banshee.31 Long-Term’s partners and most of the staff worked for a year for $250,000—pauper’s wages by their standards—to unwind the fund’s positions and pay back most of the emergency creditors.32 Hilibrand, in debt for $24 million, signed the employment contract with tears streaming down his cheeks.33 Most of them got good jobs afterward. Meriwether made a comeback to start a smaller, less leveraged fund, taking some of his team. People thought the partners had gotten off light, considering that they had nearly sent the whole financial world into a seizure. And Buffett considered it one of the great missed opportunities of his life.
Eric Rosenfeld had an insight. Maybe models didn’t work when the world went mad. For that you needed a lot of capital, the kind that Berkshire Hathaway offered. After all, if you were going to bet by a hundred billion or more in favor of risk, you needed a partner, even a parent, one with so much capital that it essentially undid the leverage, somebody to provide a big umbrella in a storm.34 By implication, maybe they would have been better off being owned by somebody like Berkshire Hathaway. But that would have meant giving up their ownership.… You couldn’t have it both ways. If you wanted Berkshire to take the risk and put up the money, to it went the gains.
To think otherwise was unrealistic—that one could lay off risk to someone else while keeping the rewards. But that point of view was beginning to dominate the financial markets and would have profound consequences over time.
It is hard to overstate the significance of a central-bank-led rescue of a private money manager. If a hedge fund, however large, was too big to fail, then what large financial institution would ever be allowed to collapse? The government risked becoming the margin of safety.35 No serious consequences had followed the derivatives near-meltdown. The market afterward seemed to behave as if no serious consequences ever could. This threat, the so-called “moral hazard,” was a chronic worry of regulators. But the world would always be full of people who loved risk. When it came to business, Buffett’s veins were filled with ice, but plenty of other people’s pulsed with adrenaline. Some of them had even been members of his own family.