WARREN WALL BUFFETT AND STREET The Best of Frenemies © Louie Psihoyos/CORBIS © Louie

16 FINANCIAL HISTORY | Fall 2015 | www.MoAF.org Lawrence A. Cunningham Buffett’s cultivation of a reputation for price of $7.14, or just under $5 billion. offering hands-off long-term capital dates Such a stake is worth more than twice that In 1965, when 35-year-old Nebraskan back to 1973 when Berkshire accumulated today ($11.2 billion at the stock’s recent Warren Buffett took control of Berkshire a stake in The Washington Post Co. Buf- price of $16) and would represent a greater Hathaway, Inc., a dying New England fett vowed loyalty to CEO Kay Graham, than 6% interest in the bank. If Berkshire textile company, the local press portrayed who soon asked him to join the board. In exercises the warrants in 2021, on the eve him as a Wall Street takeover artist: a 1986, Buffett went further when Berkshire of expiration, it will add to an invest- liquidator of the sort that inspired Danny took a large position in Capital Cities/ ment portfolio already boasting such big DeVito’s fiendish character in “Other ABC, giving its managers, Dan Burke stakes in venerable institutions of finance, People’s Money.” True, Buffett acquired and Tom Murphy, proxy power to vote including American Express, Moody’s Berkshire on the cheap — for a fraction Berkshire’s shares as they saw fit. During Investor Service and Wells Fargo. of its $22 million book value of $19.24 that era of hostile takeovers, Berkshire and Berkshire and Buffett have always been per share — and eventually shuttered the Buffett likewise backed managers against bullish on corporate America, yet they mills. But he has always campaigned vig- raiders at companies such as Champion behave quite differently from most man- orously against hostile bids, heavy bor- and Gillette, and defeated Ivan Boesky’s agers and their Wall Street advisers alike. rowing, asset flipping and other contro- run at Scott Fetzer, paying $315 million For instance, unlike most American cor- versial Wall Street practices. to acquire the conglomerate, which Berk- porations and their financiers, Berkshire Buffett became a vocal critic of Wall shire still owns to this day. shuns debt as costly and constraining. Street, as he favored cash to debt, held Wall Street values Buffett’s reputation Since 1967, the preferred form of leverage companies for the long term and defended along with Berkshire’s balance sheet. In the has arisen from internal insurance opera- trustworthy managers against short-term 25 days after the 2008 collapse of Lehman tions. Customers pay premiums up front pressures. His oratory sounded more like Brothers, Berkshire invested $15.6 billion in exchange for claims to be paid later, if at the high-minded defender of the corporate in numerous companies, when most of all, and insurers get to invest the proceeds, bastion in “Other People’s Money,” played corporate America was starved for credit. called float, in the interim. Float offers by Gregory Peck, than an apostle of greed. For one, Berkshire staked $5 billion for more attractive leverage than debt since Speaking as the reluctant interim chairman preferred stock in Goldman Sachs, paying there are no coupons, due dates, cov- of Salomon after its 1991 bond trading scan- a 10% dividend and redeemable for a 10% enants — or Wall Street bankers and fees. dal, for instance, Buffett famously broadcast premium. Berkshire also got an option to Berkshire now owns marquee companies to Congress a new credo given to his Wall buy a similar amount of Goldman com- in the insurance field, including National Street bankers: “Lose money for the firm, mon stock at $115 per share, below the mar- Indemnity, GEICO and Gen Re, and com- even a lot of money, and I will be under- ket price of $125, making it “in the money.” mands float exceeding $85 billion. standing; lose reputation for the firm, even In 2011, after the crisis passed, Gold- In typical takeovers, whether by stra- a shred of reputation, and I will be ruthless.” man redeemed the preferred. So Berkshire tegic buyers across corporate America or In addition to steady criticism, how- earned a few years of dividends plus the financial buyers from Wall Street, acquir- ever, Buffett has also been a vital friend to buyback premium, adding to $1.8 billion. ers always intervene, invariably change Wall Street. His stint as Salomon chair- In early 2013, Berkshire exercised its option strategy and frequently replace manage- man followed from Berkshire’s “white to buy Goldman common. Rather than pay ment. Berkshire’s opposite tack makes it squire” stake in the investment bank, the $5 billion cash price (then worth $6.4 an attractive alternative for sellers of busi- designed to deter a hostile takeover bid. billion), Berkshire took stock valued at the nesses seeking autonomy. They also relish The year was 1987, when Salomon’s largest difference of $1.4 billion. Berkshire’s total Berkshire’s sense of permanence, particu- shareholder grew frustrated with manage- gain on its $5 billion investment was $3.2 larly compared to Berkshire’s rivals from ment and flirted with selling a 12% block billion, 64% in a few years — along with 3% Wall Street’s private equity funds. In pri- to Ron Perelman, the corporate raider of Goldman’s common stock it still owns. vate equity’s leveraged buyouts, businesses who had recently seized control of Revlon. Meanwhile, Bank of America contin- face not only leverage and intervention, but Fearful of being next, Salomon CEO John ued to struggle to the point where, in the funds charge high fees and make quick Gutfreund turned to Buffett, who pledged 2011, it likewise turned to Berkshire for a exits, meaning rapid change followed by a fidelity while buying a sizable issue of con- $5 billion investment. Berkshire received sale. Berkshire, in contrast, imposes no fees vertible preferred stock yielding 9%. preferred stock paying a 6% dividend and has not sold a subsidiary in 40 years. and redeemable for a 5% premium. In While Wall Street sponsored hostile addition, Berkshire obtained warrants to bidders and junk-bond buyouts to break purchase 700 million shares of the bank’s up vast conglomerates, Buffett was not common stock at a per share exercise only defending corporate managers but © Louie Psihoyos/CORBIS © Louie Berkshire Hathaway CEO Warren Buffett.

www.MoAF.org | Fall 2015 | FINANCIAL HISTORY 17 The GiftThe of History. — Courtesy of Scripophily.com Rare specimen Class B stock certificate from Berkshire Hathaway Inc., printed in 1996.

building Berkshire into one of the larg- principal and interest. It is not because of Berkshire’s $22 billion 1999 acquisition est conglomerates in history. Today, in customer credit quality, which is weak, of Gen Re, also paid in Berkshire stock, addition to an investment portfolio of two but because despite low credit scores, dramatized the pitfalls: unbeknownst to dozen stocks worth more than $100 bil- Clayton only lends to borrowers on terms Buffett when Berkshire bought Gen Re, its lion, Berkshire is comprised of 65 different they likely can repay — based on an exam- underwriting standards had deteriorated, wholly-owned subsidiaries, nine of which ination of assets and income and without its derivatives book had become bloated would be Fortune 500 companies standing escalating “teaser” interest rates. and its exposure to catastrophic risks was alone. The conglomerate is worth more Berkshire’s unique practices do not unduly concentrated. Without Berkshire, than $500 billion with a per share book always succeed. Take its aversion to mid- Gen Re’s losses covering the 9/11 terrorist value exceeding $100,000 — marking a dlemen in the acquisitions arena. Berk- attacks on New York’s Financial District 20% compound annual growth rate from shire does not scout for deals but rather would likely have rendered it insolvent. Buffett’s assumption of control. “waits for the phone to ring,” as Buf- Consider Buffett’s trust-based philoso- Berkshire’s Clayton Homes subsidiary fett puts it. Buffett evaluates opportuni- phy of granting managers unbridled auton- is the nation’s largest builder and financier ties alone or with advice only from Vice omy. While lauded within the company of manufactured housing, most sold to Chairman Charlie Munger, foregoing the and responsible for much of Berkshire’s lower income Americans. On Wall Street, professionals that most companies hire to success at the subsidiary level, costly man- Clayton repackages substantial portions conduct due diligence. While the practice agement shifts sometimes result. Costs are of its loans into mortgage-backed securi- has generally yielded strong results, costly revealed in several well-publicized CEO ties. In 2008, investors in other securitized mistakes have occurred, ranging from the departures, including multiple successive mortgage loans faced steep defaults, due total loss of $443 million paid in 1993 using resignations within several years at each to lax lending practices of originators Berkshire stock for a disintegrating shoe of Benjamin Moore, Gen Re and NetJets. along with poor quality control during the maker to a $1 billion after-tax loss on debt The most dramatic departure occurred securitization process. But Clayton’s secu- Berkshire staked in 2007 on a failed lever- in 2011 when David Sokol, widely seen as ritized loans fully performed, repaying all aged buyout of Texas utility companies. a likely successor to Buffett, was caught

18 FINANCIAL HISTORY | Fall 2015 | www.MoAF.org The GiftThe of History. — Courtesy of Scripophily.com Berkshire Hathaway Inc. stock certificate, dated March 17, 2010.

front-running: a form of insider trading journalism targeting them. One such exposé corresponding costs. His core message in which he bought shares in a publicly attacked Berkshire’s practice of generat- for Wall Street remains valuable: simplic- traded stock, Lubrizol, ahead of pitching ing substantial funds from float, suggesting ity. Parsimony and frugality underpin the the company as a Berkshire acquisition it gives personnel at National Indemnity Berkshire model which, while imperfect, candidate. While the scandal prompted perverse incentives to avoid or delay paying has delivered substantial net gains, thanks questions about Berkshire’s lack of for- legitimate claims — even in bad faith. to these hallmarks: investment in reputa- mal vetting and grooming of top execu- Another piece challenged Clayton tion; commitment to trust, loyalty and tives, Buffett’s response also raised eye- Homes, arguing that its employees pres- autonomy; avoiding hostile or leveraged brows. After Buffett learned of Sokol’s sure customers into unaffordable financ- acquisitions; self-reliance in corporate front running, he drafted a press release ing arrangements and follow up with administration; and permanent owner- himself. The release, which spoke of aggressive collection practices. After pub- ship of subsidiaries. Sokol’s “extraordinary” contributions to lication, both subsidiaries and Berkshire Fifty years after Buffett took control of Berkshire and expressed Buffett’s opinion corrected errors in the stories, but the Berkshire, the 85-year-old Omaha denizen that Sokol had done nothing illegal, drew damage had been done. A full-time pro- still has much to offer Wall Street, in capi- sharp criticism, given Buffett’s traditional fessional who makes engagement with tal and wisdom alike. He is certainly more high standard of rectitude. journalists a top priority would likely have Peck than DeVito. The approach reflected Buffett’s antipathy altered the shape of the original reports, a to corporate bureaucracy, which similarly better outcome than the thrust and parry Lawrence A. Cunningham, a professor translates into substantial net savings, but that now defines the public record. Berk- at George Washington University, is the with costs. For instance, Berkshire has no shire acts as if it is small, but it is a Goliath co-author and publisher of The Essays centralized departments such as communi- to reporters and readers alike. of Warren Buffett: Lessons for Corpo- cations, human resources or legal. Yet such Buffett is critical of Wall Street and rate America and author of Berkshire frugality can leave subsidiaries flatfooted other financial intermediaries primar- Beyond Buffett: The Enduring Value of in response to the inevitable investigative ily for unnecessary complexity and Values.

www.MoAF.org | Fall 2015 | FINANCIAL HISTORY 19