Berkshire Hathaway Part II

[0] Guess how many grams of sugar are in this normal looking size bottle of cherry Coke?

[1] Is that 20 ounce?

[2] It is 20 ounce, yep.

[3] 40.

[4] Nope.

[5] 50.

[6] 70.

[7] In a 20 ounce bottle, there's 70 grams of sugar.

[8] 70 grams of sugar in one 20 ounce bottle.

[9] Wow.

[10] I can't believe they still sell this stuff.

[11] Welcome to Season 8, Episode 6 of Acquired, the podcast about great technology companies and the stories and playbooks behind them.

[12] I'm Ben Gilbert, and I'm the co -founder and managing director of Seattle -based Pioneer Square Labs and our venture fund, PSL Ventures.

[13] And I'm David Rosenthal, and I am an angel investor based in San Francisco.

[14] And we are your hosts.

[15] On our last episode, we told the story of Warren Buffett in the years of running his own partnership.

[16] those 12 years leading up through 1969 when he shut it down after his best year ever and returned all the money to his investors.

[17] Today, we will pick up right where we left off, telling the story of the declining suit liner manufacturer that he bought, Berkshire Hathaway.

[18] Today's story is one of an investment style in transition, from a focus on cigar butts to a focus on wonderful businesses, much of which was inspired by the man, only briefly mentioned so far, Charlie Munger.

[19] Now, you may be thinking to yourself, boy, it'll be really great to get the other half of the Berkshire story to understand where they are today.

[20] Unfortunately, you should know David and I better than that.

[21] We were foolish to think that we could tell the whole Berkshire story in a mere two episodes.

[22] So this episode is our Empire Strikes Back.

[23] It will serve as a bridge between the early forces that made Warren and the mature Berkshire that we have today?

[24] What made Buffett start investing again after dissolving his partnership?

[25] And why on earth did he decide to do that inside of the shell of the declining Berkshire instead of just starting a new fund?

[26] And even how did he end up briefly as the chairman of a Wall Street bank with a culture that he had criticized for his whole investing career?

[27] So here we are, part two of our Berkshire Hathaway trilogy.

[28] This really is the Empire Strikes Back.

[29] It's going to get dark at the end.

[30] Truly.

[31] Be prepared.

[32] There's a little bit of an apt analogy there.

[33] It's true.

[34] Well, folks, are you an Acquired Slack member yet?

[35] If not, what on earth have you been waiting for?

[36] It is a wonderful community discussing, of course, all things acquired in recent episodes, but more importantly, it is a smart group of people having thoughtful, nuanced, and respectful discussion about tech investing.

[37] You can join at Acquired .fm slash Slack.

[38] Okay, listeners now is a great time to thank one of our big partners here at Acquired, ServiceNow.

[39] Yes, ServiceNow is the AI platform for business transformation, helping automate processes, improve service delivery, and increase efficiency.

[40] 85 % of the Fortune 500 runs on them, and they have quickly joined the Microsofts at the NVIDias as one of the most important enterprise technology vendors in the world.

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[42] they're also a major partner of both Microsoft and Nvidia.

[43] I was at Nvidia's GTC earlier this year, and Jensen brought up ServiceNow and their partnership many times throughout the keynote.

[44] So why is ServiceNow so important to both Nvidia and Microsoft companies we've explored deeply in the last year on the show?

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[46] So whether you're looking for AI to supercharge developers and IT, empower and streamline customer service, or enable HR to deliver better employee experiences, ServiceNow is the platform that can make it possible.

[47] Interestingly, employees can not only get answers to their questions, but they're offered actions that they can take immediately.

[48] For example, smarter self -service for changing 401K contributions directly through AI -powered chat, or developers building apps faster with AI -powered code generation, or service agents that can use AI to notify you of a product that needs replacement before people even chat with you.

[49] With ServiceNow's platform, your business can put AI to work today.

[50] It's pretty incredible that ServiceNow built AI directly into their platform.

[51] So all the integration work to prepare for it that otherwise would have taken you years is already done.

[52] So if you want to learn more about the ServiceNow platform and how it can turbocharge the time to deploy AI for your business, go over to service now .com slash acquired.

[53] And when you get in touch, just tell them Ben and David's you.

[54] Thanks, service now.

[55] Now lastly, if you aren't an LP, you should become one.

[56] Aside from all the things that we tell you, every time we have a brand new LP event coming up that we are super excited about.

[57] Our next book club will be with Brad Stone, who famously wrote the Everything Store, the Upstarts, and now, David, what is his new book?

[58] Amazon Unbound.

[59] Part two of the Amazon story.

[60] Just like this is part two of the Berkshire story.

[61] So our new format for the book club will be that David and I are going to interview Brad, and if you're at LP, then you get to join on the Zoom as well, and we'll have time for Q &A.

[62] And everybody will hopefully have read the book before we do the interview.

[63] So you can join at Acquired .fm slash LP and learn more about that program.

[64] All right, David, before you take us in, and listeners, as always, the show is not investment advice.

[65] David and I may, and I think we've already told you that we do have investments in the company.

[66] that are discussed on this episode, and this show is for educational and entertainment purposes only.

[67] All right.

[68] Let's get to it.

[69] We got a lot to get through here.

[70] Yep.

[71] So last we left our friend Warren Skywalker, Warren Buffett, he was wandering in the woods of Omaha after having closed down the partnership, as you alluded to Ben, and trying to figure out what to do with his life and his retirement.

[72] So before we pick back up with him, that story, though.

[73] I think we have some unfinished business and a character that we need to introduce here.

[74] This is like so, David, even in an episode where we've already told you like a multi -decade history and we're like into part two, somehow you're finding a way to wind the clock back.

[75] Indeed.

[76] And we go all the way back to New Year's Day on 1924 in Omaha, Nebraska, the very same woods that Warren is wandering in.

[77] That sounds like six years before Warren was born.

[78] Yep, six and a half years before Warren was born, where in Omaha, Al and Florence Munger, Florence gives birth to a baby boy whom they name Charles Thomas Munger after his grandfather, who is a widely respected federal judge in the Nebraska U .S. District Court, pointed by Teddy Roosevelt himself, Thomas Charles Munger.

[79] So Charles Thomas Munger, named for his grandfather, Thomas Charles Munger.

[80] And he takes after his grandfather in many ways.

[81] His grandfather makes a big impression on him.

[82] Thomas's mantra in life was, concentrate on the task immediately in front of you and control your spending.

[83] Sort of sounds similar to Ernest Buffett, similar ideals.

[84] And this kind of instills this idea of gaining wealth through controlling your spending and focusing on doing a great job at the task in front of you in young Charlie.

[85] And Charlie, much like Warren, decides that he wants to become wealthy so that he can not have lots of fancy toys to play with, but so that he can be independent.

[86] He has a quote.

[87] He says, I wanted to get rich so I could be independent, like Lord John Maynard Keynes.

[88] Of course, elementary school -aged Charlie Munger is aspiring to be like John Maynard Keynes.

[89] So this is where he's a little different than Warren.

[90] They really have the same aims and goals in life, but their styles around it are very different.

[91] Warren is just like, I don't want anybody telling me what to do.

[92] Charlie's like, oh, I want to be like Lord Keynes.

[93] So as we chronicled in part one, Charlie actually goes to work for Ernest Buffett at the grocery store as a kid.

[94] Unbelievable for Warren's grandfather.

[95] Just like Warren learns he, hates manual labor and being paid a pittance of salary and he thinks there's got to be a better way.

[96] He can use his mind to make money rather than his manual labor.

[97] And speaking of his mind, he loves to read.

[98] His parents give him and his sisters lots of books.

[99] He tears through them.

[100] And very early in life, he stumbles across Ben Franklin.

[101] And Ben Franklin would become his hero in life.

[102] and that's where he develops this idea.

[103] I don't know if he stole it from Franklin or if he came up with it himself of making friends of the eminent dead.

[104] He decides he enjoys more the company of dead people and learning from them through their books than people who are actually alive.

[105] Kind of a one -way conversation, but there's probably a lot of wisdom there.

[106] Not to mention, like, revisionist histories and survivorship bias, yada, yada, yada.

[107] I think a lot of conversations with Charlie are one -way conversations.

[108] as we shall see.

[109] So also Lake Warren, he's kind of a wise ass as a kid and has a very high opinion of himself.

[110] His neighbor, one Ed Davis, who we discussed in part one, the doctor, is his father, Al's best friend.

[111] And just as a refresher, the Davis's would become one of the first families to invest in Buffett's first partnership, right?

[112] Yeah.

[113] And I think the first, if I remember right, the family in Omaha that gave him the most, money of sort of the initial group.

[114] I think they gave him $100 ,000 because Warren reminded them of Charlie.

[115] So he ends up going to Michigan for undergrad.

[116] Sorry, Ben.

[117] It's all right.

[118] These days, I'm not sure there's much of a rivalry anyway.

[119] Oh, burn, burn, of course.

[120] Ben went to Ohio State.

[121] So where at Michigan he majors in math and gets turned on to physics, where he becomes really entranced with physics.

[122] And then while he's still at Michigan, Pearl Harbor happens and the U .S. enters World War II.

[123] Charlie joins the Air Force.

[124] And as part of the intake process, they measure his IQ.

[125] And he's literally like one of the top IQ scores that the military and like any branch has ever tested.

[126] No major surprise there.

[127] Yeah, no major surprise there.

[128] He's probably the, you know, top wise ass decile as well.

[129] That is definitely true.

[130] So they send him first to the University of New Mexico to study engineering there.

[131] He then goes on to Caltech in Pasadena and Los Angeles and continues his engineering studies there.

[132] And then I think he ends up, if I'm remembering this right, I don't have it in my notes.

[133] I think he ends up getting stationed in Alaska as a meteorologist during the war.

[134] I remember him being in Alaska too as part of his duty.

[135] Yeah.

[136] So anyway, after the war, he decides that he really enjoyed learning about engineering and physics and math and all that.

[137] But for a career, he more wants to follow in the family footsteps of his beloved grandfather and his father and go into the law.

[138] So Charlie being Charlie, he applies to Harvard law, despite the fact that he doesn't have an undergraduate degree.

[139] Why should that stop him?

[140] Yeah, he didn't actually graduate from any of these institutions.

[141] And he gets in.

[142] And he goes to Harvard Law.

[143] He does very well there.

[144] Graduates Phi Beta Kappa.

[145] And he decides after graduation, he's thinking about going back to Omaha.

[146] But he decides, well, one, Pasadena was really nice when I was there at Caltech.

[147] The weather in L .A. is hard to beat.

[148] But also, in typical Charlie fashion, he sort of asked himself a rhetorical question.

[149] He's like, where can I be somebody?

[150] And, you know, Omaha is obviously a rising town, great city, but it's not Los Angeles.

[151] He says, what city is growing and full of opportunity so that I could make a lot of money, but not so big and well developed that it would be hard to rise into the ranks of the city's most prominent men, which, of course, Charlie wants to be among those ranks.

[152] And you're already seeing a massive departure in the sort of psychological makeup of Warren and Charlie here, where, like, that was never a thing Warren cared about.

[153] It was, like, how much money will I have on the scoreboard when I die?

[154] And, like, I'm sure, no matter where I live, that'll get compared to everyone else.

[155] And for Charlie, it was, you know, where can I be a man about town?

[156] And that town should be big enough to be worth being a man about town.

[157] And it's also funny to me that at this point, like, L .A. is for him something that he views as, like, oh, it's not too big yet.

[158] Yeah.

[159] Well, it wasn't, I mean, right after World War II, obviously, it was a big town and Hollywood had always been there, but I think California, and particularly Southern California, experienced a huge population boom after World War II, of which Charlie was part.

[160] So very tragically, after moving to L .A., he had gotten married, I think right after the war when he started at Harvard, and tragically, both his marriages falling apart when he gets to L .A. And much more tragically, his son, Teddy, is diagnosed with leukemia.

[161] And in those days, there was no effective treatment for leukemia.

[162] Yeah, just tragic.

[163] It was totally tragic.

[164] And Teddy would end up passing away in 1955 at age nine, which is unimaginable to lose a child at all, let alone in that way and at that age.

[165] Charlie's reaction to this, I think is very characteristic, very telling of who he is.

[166] He's obviously absolutely devastated, but he decides that the thing to do is he needs to set new goals for himself and move forward versus being consumed by grief.

[167] So he says after about when reflecting on this time, he says one of his Charlieisms, you should never, when facing some unbelievable tragedy, let one tragedy increase into two or three through your failure of will, which is probably, you know, sound advice, not that I can imagine going through that.

[168] That's also some incredible compartmentalization.

[169] I mean, for imagine going and speaking to a person who's grieving right now and telling them, hey, don't let this turn into two or three, cascading, what is it, failures or catastrophes.

[170] It's sort of only something you can decide and tell yourself.

[171] And I think only if you are a person like that.

[172] like Charlie.

[173] Like Charlie.

[174] So he sets two very specific goals for himself.

[175] One, to find a new spouse and two, to diversify his business activities outside of law.

[176] And so on one, I thought this was so funny.

[177] He's really worried.

[178] He's now a divorced man in his 30s in California.

[179] He doesn't know that many people out there.

[180] He goes through all the math of like how many women are there in California, how many would be of a marriageable age, how many are smart enough for me, but not too smart.

[181] Of course, this is Charlie.

[182] So he happens on a foolproof strategy.

[183] He decides that he's going to do the most rational thing possible.

[184] He's going to start every day scanning the divorce and obituary notices in the paper.

[185] What?

[186] Looking for widows and recent divorce days.

[187] Oh, my God.

[188] I guess there weren't.

[189] dating websites back in those days.

[190] So that's what you had to do.

[191] His friends are kind of alarmed by this.

[192] And one of his law partners introduces him to a woman named Nancy Borthwick, who was kind of fit all of his criteria, except maybe the not being too smart.

[193] She was quite smart.

[194] She was recently divorced.

[195] She was five beta Kappa from Stanford undergrad in economics.

[196] She actually had an undergrad degree, unlike Charlie.

[197] And most importantly, she took nobody's crap, including Charlie's.

[198] So they, each of the two of them have two children, two surviving children from their previous marriages.

[199] They get married.

[200] They go on to have four more children together for an entire munger clan of 10 people, eight children and two parents.

[201] It's a lot of mongers.

[202] That is a lot of mongers.

[203] And if you see photos of them of the munger clan to this day, especially with all the grandchildren, it is impressive.

[204] It's like a small.

[205] city.

[206] Do you know the, this is sort of like the thing that smacks you in the face, the thing she had in common with his first wife?

[207] Uh, yes, her name.

[208] Yeah, they're both named Nancy.

[209] Like, yeah.

[210] In some ways, you're like, come on, that's pretty lazy.

[211] Like, you can't go marry someone again with your same.

[212] Someone once made a remark that Charlie was so sort of absent -minded and forgetful of names that, thank God, his second wife was also named Nancy or he would have forgotten her name too.

[213] Yeah, very Charlie.

[214] He is unique.

[215] So on goal number two, he's doing very well as a lawyer in L .A. As you can imagine, Charlie is an excellent attorney.

[216] But he decides that, you know, even though he's having all this success, really the people who seem like they have the good life and who are really the sort of, you know, men and they're all men at this point about town are the clients.

[217] In particular, one of his clients is the mining magnet Harvey Mud, who helped build Caltech into what it became and then helped build and found all of the Claremont colleges, including the one that bears his name, Harvey Mud.

[218] He was one of Charlie's clients.

[219] So what does Charlie do?

[220] He starts buying some stocks himself, but he also starts taking some of his fees from his clients in equity in addition to cash.

[221] Yeah, he's like the early you know, Silicon Valley, you know, entrepreneurial startup lawyer type that takes some equity in addition to cash for doing the deals.

[222] He also ends up getting into real estate, which real estate in Southern California in the post -war era was a great way to make a lot of money.

[223] He gets his net worth up to about $1 .5 million by the early 60s, which if you remember from part one, he's like right neck and neck with Warren at this point in time.

[224] And that's what, like 10, 15 million today?

[225] Yeah, so it's certainly more than anybody would need to be living the good life of a man about town at this point.

[226] Right, and you could imagine like someone in their mid -30s, like you could kind of just live off that interest forever if you wanted to put it into fixed income and, you know, kind of call it.

[227] Totally, totally.

[228] Which, unlike Warren, Charlie's not necessarily against.

[229] something like that.

[230] He's definitely enjoying himself in L .A. But along the way, as we alluded to in part one, the famous summer night in 1959 in Omaha, Charlie is back in town briefly to settle his father's estate.

[231] His father Al had passed away.

[232] And the Davises say, ah, we're now, we're investors with this local guy, Warren, we've told him about you.

[233] Three years ago, we met him.

[234] He seemed like you.

[235] Let's set up a dinner and you guys can, we'll introduce you.

[236] You guys can meet.

[237] Both Warren and Charlie, I think, are skeptical going into this dinner.

[238] But the legend goes that they all sit down to dinner and it's like electric.

[239] Warren and Charlie hit it off right away, which I think is true.

[240] And then the legend goes that at this dinner, Charlie starts laughing at one of his own jokes so hard that he actually rolls out of his chair onto the floor and starts rolling around on the floor.

[241] Now, that is not true, but it did happen later that week because Warren and Charlie got dinner together like every night that week after that they were there.

[242] And yes, apparently Charlie did actually start rolling on the floor of a restaurant at one of his own jokes.

[243] which is the first of like many like pretty funny quips about charlie at dinner parties and his eating habits and his mildly self -absorbedness when it comes to these things there's another good one where he's been known to as he's telling a story or opining on something sometimes of course like he'll need to drink water so as he sort of takes his glass and puts it up to his mouth he puts his hand out to stop anybody else from talking and holds his hands up until he's done taking a sip and then moves his hand down so he can finish telling the story.

[244] Like this is a man that loves to talk.

[245] It doesn't come out as much in Berkshire meetings until you sort of get him going.

[246] But yes, in social situations, he is the center.

[247] It's so funny because if you just watch the annual meetings, you would think that Charlie is the silent partner.

[248] Nothing could be farther from the truth.

[249] So during this dinner, Warren and Charlie are like enraptured with each other.

[250] And as they go along, Charlie's getting more and more puzzled because all Warren is talking about is businesses, companies, and investing.

[251] And Charlie loves this.

[252] He thinks this is great.

[253] But it wouldn't even cross any normal person's mind that this could be your job at this point in time.

[254] You know, like we talked about in part one, like maybe a couple people in New York, you know, maybe Ben Graham could do this.

[255] But the idea that somebody in Omaha, even somebody in L .A. could do this as their full -time job.

[256] Only Warren was thinking this way at the time.

[257] So eventually Charlie asked Warren, well, what do you do exactly for a living?

[258] And Buffett's like, well, you know, I have these various vehicles, these various partnership vehicles, because at this point he hadn't consolidated them all yet.

[259] These are all, he has like seven or eight different partnerships that he invest from.

[260] And mind you, the setup is there's no fees.

[261] He's not drawing a salary from any of these.

[262] Yep.

[263] He's just working out of his spare bedroom at the house in Omaha, living off of his what was it, $175 ,000 that he had when he left Graham Newman.

[264] So Charlie, though, this strikes him as brilliant.

[265] And he's like, he looks at Warren dead serious for once.

[266] And he says, do you think I could do something like that out in California?

[267] And supposedly Warren, as chronicled, sits there and he thinks for a minute.

[268] Because, you know, Warren is, you know, he's very polite.

[269] But like, he's also, especially with people he respects, you know, very honest and direct.

[270] And, you know, he doesn't think.

[271] many people can do this.

[272] But he thinks, and he says, you know, yeah, I'm quite sure you could do this.

[273] And Charlie, you know, it changes his life this dinner.

[274] He goes back to L .A. He keeps practicing law.

[275] He's not ready to go all in yet on investing, but he raises some money.

[276] He starts a partnership and he starts emulating Warren investing on his own out in Los Angeles.

[277] Susie Buffett, who is at the dinner, although a silent participant says in a quote in the snowball.

[278] She says, I think Warren felt that Charlie was the smartest person he'd ever met.

[279] And Charlie felt that Warren was the smartest person that he'd ever met.

[280] And for the two of them, that was quite the high compliment.

[281] So Munger goes back to L .A. He starts investing.

[282] He also leaves the law firm that he was at and starts a new law partnership, which was originally called Munger.

[283] Tolls and Hills later becomes Munger Tolls and Olson, which to this very day does all of Berkshire's legal work and will become very instrumental in the story at the end, as we shall see here.

[284] But he doesn't stay there long.

[285] He only stays at this new firm that he starts for three years.

[286] And then in 1965, he's doing so well investing that with Warren's encouragement, he actually leaves MTO and just like Warren becomes full -time running his partnerships.

[287] investing.

[288] And MTO, despite the fact that Charlie was only there three years, is still MTO today, right?

[289] Still MTO today.

[290] Yep.

[291] Amazing.

[292] And I know that like, imagine starting a firm, naming it after yourself, and then leaving, and then all of your partners and everyone else who works there asking you, hey, can we still keep it with your name on it?

[293] And your name first.

[294] Right.

[295] It's wild.

[296] Totally wild.

[297] So Charlie starts out in his sort of investing style doing the cigar butts and the like.

[298] He's talking to Buffett all the time.

[299] They're always on the phone.

[300] He's absorbing all the Ben Graham philosophy.

[301] But it quickly becomes clear that he's wired a different way.

[302] So he starts saying to Warren and some of their other friends this line that is sort of puzzling to them.

[303] Charlie says, you know, I really, I just like great businesses.

[304] And that's like not computing with Warren and the rest of the crew.

[305] And Warren's like, you mean mispriced assets?

[306] Because that's what we're doing here.

[307] We're buying mispriced assets.

[308] And when you say great businesses, you know, what do you mean by that?

[309] Right.

[310] I mean, even, you know, as we talked about last time, Warren, when he gets a great business, like a GEICO or, you know, an Amex, he's still only thinking about them in terms of like the value that he can arbitrage out relative to their hard asset net worth or their cash on the balance sheet.

[311] Charlie, though, so the story goes that what really gets him down this line of thinking is at one point, he invests in a Caterpillar tractor dealership in Southern California.

[312] And this becomes a total albatross because the problem was, as the dealership, you've got to buy the tractors from Caterpillar up front.

[313] which cost a lot of money and then they don't turn over that fast they're just sitting on the lot and then every time one goes out the door you got to put more capital up to buy a new one it's like incredibly capital intensive it's always tying tying up capital and if you want to grow you want to add new stores you got to invest in all the inventory up front and so charlie ever the rationalist he realizes that like hey wait a minute the goal of owning a business should actually be one that the business spits out more cash than it consumes.

[314] And ideally, too, that it consumes as little cash as possible.

[315] Right.

[316] That then when it spits off cash, that you actually can do something with that cash, not have to go buy more caterpillar pieces of machinery.

[317] He's like, I want to give you cash once and very little of it.

[318] And then I want you to give me a lot more cash over time with me never giving you anymore.

[319] This is best paraphrased in the line from poor Charles.

[320] Lee's Almanac, which was an awesome source.

[321] Which is a better business?

[322] And it postulates there are two kinds of businesses.

[323] The first earns 12%, and you can take the profits out at the end of the year.

[324] The second earns 12%, but all the excess cash must get reinvested.

[325] There's never any cash.

[326] It reminds me the guy who sells construction equipment.

[327] He looks at his used machines, take it in as customers bought the new ones, and says, there's all my profit, rusting in my yard.

[328] We hate that kind of business.

[329] totally so all right charlie's starting to think about this and he starts really going down the rabbit hole he's like how can you like achieve such a state in business and that leads him to think about this idea of competitive advantage like this is all like probably seeming like duh normal stuff to everyone now but like nobody is thinking this way at the time and what is competitive advantage it's it's almost like a moat it's like if your business is a castle you have a moat around your castle so that nobody can attack it.

[330] It's a reason why competitors can't come and arbitrage your differential profits away.

[331] It kind of sounds like Hamilton Helmer empowers, right?

[332] So Warren and Charlie are spending a lot of time together.

[333] Famously, Warren and Susie start vacationing in Southern California just so that Warren and Charlie can talk for hours.

[334] And when they come out, Warren's already a millionaire at this point.

[335] The family stays in a motel on Santa Monica Boulevard and then commutes over, drives over to pass over.

[336] Pasadena, of course.

[337] So, one, they're hanging out because they respect each other's intelligence, but two, Alice points out in the snowball, there's actually a second reason why Warren likes Charlie so much.

[338] And that's that as Warren's starting to get more and more known in Omaha and on the national scene for his investing track record, nobody's willing to tell him he's wrong anymore.

[339] Everybody's super deferential to him.

[340] And as Alice puts it, Charlie's deference.

[341] to Warren was limited by his high opinion of himself.

[342] That's awesome.

[343] And that is something that we start to see play out here in the late 60s where, you know, Buffett was famously very shy about ever sharing investment ideas.

[344] I think like occasionally at that annual group that he would convene of all the Ben Graham disciples, his fellow classmates, which he then started bringing Charlie into that they would occasionally sort of allude to some investing ideas they were thinking about.

[345] You know, maybe this business is interesting, but they would kind of talk around it.

[346] Warren really found in Charlie someone that he could literally present, here's the name that I'm thinking about, and start talking through the business and look for sort of holes in his thinking in a way that he never opened up to anyone else to ever say the name of a company he was thinking about buying.

[347] Yep, totally.

[348] That brings us back to, at the same time, Charlie's starting to go down this different path in philosophy.

[349] And Munger starts saying, and he says to Buffett, he's like, hey, you're like obsessed with this Graham guy.

[350] And like, I'll give it to you that that's a great strategy.

[351] It works.

[352] He met Graham at several points this time.

[353] Graham also lives in Southern California by now.

[354] But he's like, hey, he's not God.

[355] And there's a flaw in the cigar butt thinking, which is that it was driven by the environment that Graham came of age in and the depression.

[356] And the quote from Charlie is that the flaw is that Graham believes that the future is more fraught with hazard than ripe with opportunity.

[357] And here in the post -war era in the U .S., especially in California, it's super hard to look out of the future and not see opportunity.

[358] So Charlie starts haranguing Warren about this.

[359] He says, is a great quote.

[360] Because Warren is so good.

[361] at explaining Ben Graham.

[362] He's behaving like the old Civil War veteran, who after a few minutes of ordinary conversation always interjects, that reminds me of the Battle of Gettysburg.

[363] In other words, Warren is falling victim to one of the oldest human misjudgment tendencies in the book, The Man with a Hammer Syndrome.

[364] And what's that like when you have a hammer or everything looks like a nail?

[365] Exactly.

[366] So eventually, Charlie does start breaking through to Warren.

[367] right around this time as Warren is shutting down the partnership.

[368] He's so, you know, he's so depressed.

[369] He's worried about the market.

[370] He doesn't see opportunity ahead.

[371] He only sees hazard.

[372] But at heart, though, Warren is an optimist.

[373] Yeah, it's interesting.

[374] When you're 95 % aligned with your teacher, it's easy to just try and do things exclusively their way.

[375] And it's only when you start really feeling yourself and feeling your legs under you a little bit.

[376] that can you start saying, wait a minute, I am a little bit different and I can act, you know, as completely my own agent rather than following their playbook.

[377] All right.

[378] So this leads us to the first big thing that Warren and Charlie do together, which is blue chip stamps.

[379] And I remember what I used to hear Warren and Charlie talk about blue chip stamps company.

[380] I thought this was like a quaint, like stamp collecting store franchise, you know.

[381] I assume that too.

[382] Yeah.

[383] Exactly.

[384] Like a baseball card shop or something.

[385] no, this is totally not what this was.

[386] So this is some like wild Americana history.

[387] And when we say the first thing they do together, we should be crystal clear here.

[388] They are not Warren and Charlie on a stage the way that you see them today.

[389] There is Charlie who is doing Charlie's partnerships and Warren who's doing Warren's partnerships.

[390] Yep.

[391] So what is blue chip stamps?

[392] So around the turn of the century, the turn of the 20th century, departures.

[393] store's used to hand out, this is crazy, they used to hand out stamps as like a bonus incentive for customers to pay cash for goods instead of buying on credit.

[394] So the idea was if you bought something with cash, the store then handed you a certain number of stamps, which you could paste into a booklet.

[395] And when you filled up the booklet, you could exchange it for like prizes, like redeem it for like a, you know, I don't know, like furniture or jewelry or like a bike for the kids or something like that.

[396] They did want to incentivize paying with cash because cash flow.

[397] Exactly.

[398] So this was a way to incentivize paying with cash.

[399] So somebody had a brilliant idea that it would be better if you actually operated the stamp service as a separate business from anyone's store so that customers can get stamps from lots of stores and then like aggregate them, get lots of stamps and then redeem them for, you know, more prizes.

[400] It sounds so convoluted when you sort of explain it this way.

[401] Totally.

[402] But this business turned out to have two extremely attractive qualities.

[403] One, it had float.

[404] So the stamps companies that were running the stamp operation, the businesses, the stores, they bought stamps in advance from the stamp company.

[405] So, like, you're a department store.

[406] You're like, I'm going to buy $500 ,000 worth of stamps that I'm then going to give out to my customers over time to incentivize them.

[407] They buy it at a distance.

[408] Wow, so you better keep those in a safe because those are like cash.

[409] Yeah, exactly.

[410] And then they would give money, give US dollars to the stamp company in exchange for the stamps.

[411] and then the customers, you know, they would of the store, they would get the stamps and then they would redeem them, there'd be breakage.

[412] You know, it could be years from the time the stamp company sold the roll of stamps to the store.

[413] Sounds like an insurance company.

[414] Exactly.

[415] Exactly.

[416] So there's float.

[417] And then two, even better, there's network effects in this business, two -sided network effect.

[418] The more stores that use a given stamp system versus another one, the more consumers are going to be incentivized to buy at those stores because they want those stamps that they can redeem for big prizes, etc. Right, right.

[419] So yeah, consumers want more stores to support it.

[420] Stores want more consumers to use it.

[421] Yeah, it makes total sense.

[422] So by the middle of the century, there is one dominant national player in the stamp business, the S &H green stamps, except in California, where a bunch of stores had banded together and shut out S &H and launched their own stamp, the Blue Chip Stamp Company.

[423] Amazing.

[424] Unbelievable.

[425] I had no idea about any of this.

[426] So in 1963, S &H and the Department of Justice both sue Blue Chip for monopolistic practices.

[427] is S &H is trying to get into California and recruits the DOJ.

[428] Why the DOJ wasn't like, hey, S &A, you're a monopoly too.

[429] But anyway, regulatory capture, I guess.

[430] Yep.

[431] So the stock gets pummeled when these lawsuits happen.

[432] But Munger's heard about this in L .A. And he tells Buffett and also their friend Rick Garen, who's part of the Graham group, which becomes the Buffett group.

[433] Remember, Munger's like a highly, highly experienced top.

[434] notch lawyer, corporate lawyer.

[435] He says, what's going to happen here is Blue Chip itself is going to be fine, but the government, what they'll do, what the DOJ will do, they're going to force all of the California store chains that collectively own Blue Chip to divest it.

[436] And who better to buy it than us?

[437] So indeed, that is what happens.

[438] In 1968, Blue Chip agrees to a consent decree with at the DOJ, where the stores have to sell off 45 % of the company, and boom, combination of Munger, Guerin, and Buffett all snap up 45 -ish percent in Bluetooth.

[439] And of course, like, this sounds complicated to me because each of them represent a different shareholder base.

[440] They're sort of talking to each other.

[441] It feels like something could be fishy there.

[442] It could be.

[443] It could be.

[444] As, uh, as, uh, the line we shall see in a minute is there's got to be an indictment in there somewhere.

[445] Okay, so now we're in 1970.

[446] Warren has just unwound his partnership and distributed out shares of Berkshire, diversified retailing, which was a JV essentially that he had with Munger's partnership to invest in department stores, ill -fated idea, and then blue chip.

[447] And remember, Warren told his partners in the letter where he said he announced that he was winding down the partnership that he intended to buy more of all of these companies.

[448] Well, he does.

[449] And so just to be super crisp here, Warren owns some Berkshire, but Charlie doesn't own any Berkshire at this point.

[450] This is 1970.

[451] I think none at this point.

[452] They've created the JV of diversifieds.

[453] They're definitely in that together.

[454] And they both sort of share this idea about Blue Chip.

[455] So they both are big holders of Blue Chip as well.

[456] Yep.

[457] So after Warren winds down the partnership.

[458] He buys so much stock in these three companies from his former partners that his ownership of Berkshire doubles from 18 % to 36%.

[459] His ownership of diversified doubles from 20 % to 39%.

[460] And he buys so much blue chip that he goes from 2 % to 13 % ownership in blue chip, just personally.

[461] So Susie's like, oh, no. Second retirement is going to look exactly like the first retirement here.

[462] And this really was the case, right?

[463] He was like, I'm winding down my partnerships, I'm done.

[464] What was the line?

[465] Something about his style and sensibilities no longer being suited to the current environment.

[466] And yet here he is heavying up on these three stocks.

[467] Yep.

[468] So Warren isn't the only one buying these stocks.

[469] Berkshire itself starts buying blue chip.

[470] So pretty soon, Berkshire, Warren owns 13 % of blue chip.

[471] Berkshire holds 17 % of blue chip, diversified, owns 16 % of blue chip, and Munger's partnership on his own owns 8 % and Garron owns 5%.

[472] So 60 % of blue chip is owned by these six different entities, all of which also owns stock in each other.

[473] Now, listeners, if you're feeling like this is convoluting and, you know, a little bit messy and, I don't know, maybe even like they might be sort of hiding something with the lack of simplicity here.

[474] So does the SEC.

[475] Which we will get to in one sec. But ironically, while they're doing all of this buying, they're just so, like, thrilled at the prospects of what they're doing.

[476] The actual business of Blue Chip enters a major secular decline.

[477] So during the decade of the 1970s, Bluechips core business, even though they settled the DOJ suit, the core business declines 90 % over the decade because consumers are just not that interested in stamps anymore.

[478] Credit cards are becoming a thing.

[479] It seems like an outdated kind of thing.

[480] So the business is declining.

[481] Then why were they so excited about buying the stock just because it was at historical lows and they felt like it was a low multiple of profits it was generating?

[482] I think the other part of it is the float.

[483] So just like Berkshire, Blue Chip is declining in its core business, but it's still got this super attractive float dynamic.

[484] And if they don't own it outright, like why is that attractive?

[485] Because they can't use that.

[486] They can't take the cash out from the float to use it for something else, right?

[487] Right.

[488] Right.

[489] They can't take the cash out of Blue Chip, but they can redeploy it within Blue Chip.

[490] So, So they say, hey, let's run the Berkshire playbook that Warren, you just did with Berkshire.

[491] Let's start looking for other operating businesses to go by with our float here at Blue Chip.

[492] So they tell Blue Chip's president, a guy named Bill Ramsey, to start looking about for companies to acquire.

[493] And one day in 1971, he calls Warren and Charlie, and he's like, hey, I've got a pretty interesting acquisition target here.

[494] It's a small little family company here in L .A. called Seas Candy.

[495] And so Warren and Charlie come in.

[496] They start looking at the company, and it's actually pretty interesting.

[497] So Seas, people love it.

[498] It becomes wildly popular across California, starts expanding.

[499] They develop a slogan that they want to be known for C's quality, which is supposed to be even better than top quality.

[500] You've got like high quality, top quality, and then C's quality.

[501] It's so ubiquitous in.

[502] California that you know the famous I Love Lucy episode where already no oh you definitely know this it's like one of the most famous moments in television in the 50s where Lucy and ethel are working in the chocolate factory and they're on the production line they're supposed to like wrap the chocolates as they go by and the chocolates start going so fast that they can't keep up and they're like stuffing the chocolate all like in their clothes oh I do know what you're talking about yeah yeah it's it's amazing it was modeled after a C's candy factory.

[503] So the problem with Seas, though, from Warren and Charlie's perspective, is it is decidedly not a cigar bud.

[504] So the factory and the stores and the hard assets on the books are valued at $5 million.

[505] But Seas already has an offer on the table for $30 million.

[506] So this like fails every Ben Graham test in the book.

[507] It's so crazy to me, this notion of cigar butts that you're trying to pay less than literally just the property plan on equipment effectively.

[508] And like we're not even talking about, you know, profit multiples here.

[509] We're literally just talking about like, well, are they asking you to pay more than the liquid value of all their assets?

[510] And like, oh no, six times the property plant and equipment.

[511] Ah, too far afield for me. But this is where, remember we were talking about Charlie's starting to get this tingling about great.

[512] businesses and he's influencing Warren.

[513] He's like, hey, Warren, let's actually look at the revenue and like earnings side of the equation here.

[514] This company is doing $4 million in annual pre -tax profit and that's growing at 12 % per year without putting any more capital into the business.

[515] It might actually be worth paying this price.

[516] So then what?

[517] That's about 8x trillion 12 months profit multiple.

[518] Totally.

[519] I mean, imagine that.

[520] That's the offer.

[521] That's the offer, right, on the table.

[522] So Warren, of course, he Hemsenhaas about it, and he's like, I can't do 30, but we could offer $25 million.

[523] And the only reason he justifies it to himself at this point is he thinks, well, they probably have pricing power because people love the candy so much.

[524] So if we raise the prices, maybe I can get comfortable with this.

[525] This is sort of the like brand notion that he's learned at this point of, hey, there actually is a thing that doesn't show up on the balance sheet that has value.

[526] Yep.

[527] He's starting to come around.

[528] So they do get the deal done with the family.

[529] Blue Chip buys Cs for $25 million.

[530] And over the ensuing years, this little candy company delivers over $2 billion in free cash flow to first Blue Chip and then when it would get absorbed into Berkshire Hathaway for a purchase price of $25 million.

[531] This is the first time that this concept of a wonderful business at a fair price versus a fair business at a wonderful price is executed by Warren and with Charlie's influence.

[532] And Warren, after a brief period of time of seeing the C's operating results, becomes a total comfort.

[533] So he would say later about this idea that it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

[534] He says, Charlie understood this early.

[535] I was a slow learner.

[536] Love it.

[537] Meanwhile, Charlie is also learning from Warren that managing other people's money maybe isn't so great.

[538] So Charlie's partnership before 1971, 72 had done not quite Buffett levels of performance, but generated 28 .3 % IRAs for the first decade, which is still fabulous performance.

[539] but not as steady as Warren.

[540] That's the thing to notice about Charlie.

[541] He did lose money some years.

[542] He did.

[543] He had some real big years and some down years.

[544] And then in 73 and 74, Charlie's partnership falls 31 .9 % and then 31 .5%.

[545] And this is super scarring for Charlie.

[546] He feels like he's got to, like if he can get almost like Warren and his sister been the first stock he bought back.

[547] in the day.

[548] He's like, if I can get the partnership level back to roughly what it was, I'm going to work like hell to do that, but then I'm out.

[549] So he does that in 75.

[550] He returns 73 .2 % on the partnership in 75, and then he winds it down.

[551] He's out.

[552] He says, you know what?

[553] Warren's having a good time with this Berkshire model.

[554] I'm going to do the same thing here with Bleachib.

[555] Yep.

[556] And the difference being, you know, Charlie was still running other people's money at that point.

[557] And I think he was doing a more traditional model management fees and effectively carried interest or some kind of promote that he was getting above some certain hurdle.

[558] But, you know, in that business, when you're losing money, you feel it really hard because you're being judged on that performance.

[559] Whereas with Warren, the only other stakeholders that he had to think about were the other shareholders in those businesses.

[560] But Warren had made no promise to them of, I'm going to be effective with your capital.

[561] it was, you know, the structure was, look, I'm invested in this company, this Seacorp, you're invested in this company, this Seacorp.

[562] Like, you can get out at any time.

[563] I'm not managing your money for you.

[564] And so he just has all this.

[565] He is the weight off his shoulders.

[566] He can only lose his own money.

[567] There's no one else to be mad at him.

[568] And, you know, if he does well, it's just for himself.

[569] But he's got a lot of money.

[570] So he can, he has the firepower of a lot of capital without it being other people's capital.

[571] Yep.

[572] And if the sack goes down, great.

[573] He's might just buy more of the stock.

[574] He doesn't need to feel terrible about it.

[575] He's not going to put up a negative number at the end of the year for someone.

[576] Right.

[577] He does want to make sure that Berkshire never goes out of business.

[578] That's incredibly important to him.

[579] But yeah, any given year's performance doesn't really matter.

[580] That's not how he looks at things anymore.

[581] All right.

[582] In 1971, back when they were starting to look at C's, Warren and Charlie for Blue Chip, Bill Ruane from the Sequoia Fund calls up Warren and says, hey, next time you're in New York, I want to set you up with one of my classmates from HBS, this guy that I really think you'll enjoy meeting.

[583] Why don't you get dinner with him?

[584] His name is Tom Murphy.

[585] This is probably the fourth episode that Tom Murphy's come up on and acquired.

[586] Yes, we've talked a lot about Tom Murphy or Murph, as he was known, and is known.

[587] He's still alive.

[588] I think he's 95.

[589] Oh, awesome.

[590] Yeah.

[591] amazing.

[592] And his partner, Dan Burke, who of course ran Cap Cities, and we talked all about them on the ESPN episode, and turned it into this incredible media empire that today is like pretty much, what, at least 50 % of Disney, more?

[593] Yeah, I think that's right.

[594] ESPN, ABC, all the television stations.

[595] And they do it all with no further capital investment after that.

[596] at one TV station, with one very large and notable exception that we're going to talk about in a few minutes here.

[597] So they get together, and Warren is immediately impressed with Murph and with Capitol Cities, and he just loves everything about this business.

[598] And of course, he's already familiar with the media industry, he's intimately familiar with the newspaper industry.

[599] He knows a little bit about the, if not television, the sort of moving picture.

[600] aspect of the media business because of maybe the second biggest investing mistake that he made after Intel, which we intentionally skipped over in part one to have the big reveal here.

[601] Ben, what is the unbelievable company that in addition to Geico, in addition to Amex, Buffett had briefly owned 5 % of during his partnership days?

[602] Disney, the freaking guy owned Disney and he sold it, like after what, two years or something of owning it when it reached its, you know, what he felt was a good price for him to get out.

[603] Unbelievable.

[604] So, yeah, I think it was, I think it was one year.

[605] So in 1966, Disney had been trading at an $80 million market cap, the Walt Disney company, and an $80 million market cap.

[606] And it's not like Disney was much smaller back then.

[607] Like, it was still.

[608] freaking Walt Disney and it had the theme parks and everything.

[609] Mary Poppins had just came out and made $30 million at the box office.

[610] And the stock went down because Wall Street was like, oh, well, movies, that's a hits driven business.

[611] You know, the next couple of years, comps are going to be real tough after that Mary Poppins.

[612] Like Mary Poppins just made $30 million in revenue and the whole company is valued at a market cap of $80 million.

[613] Yes, yes.

[614] Unbelievable.

[615] Louis.

[616] Warren, though, being smart, being Warren, he's like, wait a minute, it's Mary Poppins.

[617] They're going to be able to generate revenues for years after this.

[618] Like, kids aren't only going to want to see Mary Poppins once.

[619] And in one year, every generation of kids is going to want to see this thing.

[620] Take it out of the Disney Vault.

[621] So he values the company in his head just off Mary Poppins.

[622] He's like the theme parks, all the other movies.

[623] Let's assume all that's zero.

[624] That's my margin of safety.

[625] He thinks that.

[626] It's still worth more than $80 million just on Mary Poppins.

[627] He puts $4 million of a partnership capital into Disney, buys 5 % of the company.

[628] And then, of course, Warren being Warren at the time, within a year, he's made $2 million on that.

[629] He's made a 50 % return, and he sells the whole thing.

[630] My God.

[631] What's the quote, better to be approximately right than precisely wrong?

[632] Like, sure, he was approximately right, but you have to stretch that approximately pretty far to be like it was the right decision for you to get out of that business.

[633] I mean, okay, so the principle of that quote is, look, there's no way that you're going to be able to exactly know the intrinsic value of the company.

[634] So you will never know exactly what you should pay for it either on your entry price or your exit price.

[635] So, you know, it's the margin of safety idea that you should be approximately right.

[636] So if you can get a big margin of safety, then you're sort of okay on the entrance price and you're okay on the exit price, even if they're not precisely correct?

[637] Well, like, you were way, way off on what the intrinsic value of this enterprise could be.

[638] And like, sure, you made money, but this is the sin of, I suppose it's omission because it's that he didn't continue to make money.

[639] In a way, it's commissioned because he actually had to act to sell the stock.

[640] But gosh, how different his net worth would be.

[641] And who knows about Berkshire's future.

[642] But if he had continued to hold 5 % of Disney at that point.

[643] Totally.

[644] I mean, Geico, Amex, Disney.

[645] We're not even talking about Intel.

[646] These are all companies that Buffett owned like a meaningful percentage of in his very early days and didn't hang on to him.

[647] No. All right.

[648] So he knows about the moving picture business from owning a little bit of Disney.

[649] So he's sitting down.

[650] He's sitting down with Murf.

[651] He and Murph are passionate out and Murph says to him what?

[652] Murph says after the dinner, Murph is so impressed with Warren's you know, sort of like management, investing mine, like these are two people cut from the same cloth.

[653] He decides that he wants Warren to join his board.

[654] So he flies out to Omaha.

[655] He makes a pilgrimage to go see Warren.

[656] And he says, hey, I really want you to join the Capital Cities board.

[657] He would have been really impressed with Warren's head office.

[658] Yeah, exactly.

[659] Like if you think about how Capital Cities was like incredibly lean, this is like the only person who would walk into Warren Buffett's office, look around and be like, awesome.

[660] I love it.

[661] I think there's some famous story.

[662] Timmy's tell on the ESPN episode about how they only painted the fronts of their buildings and not the sides in the back.

[663] I don't remember that.

[664] That sounds right, though.

[665] Amazing.

[666] So Warren's like, look, Tom, I love you and Dan.

[667] But honestly, the only way that I can join your board is if I were to own a large chunk of your company.

[668] And this is like an impasse because just like Warren, Tom equally feels like issuing stock is the ultimate sin, and he refuses to do it.

[669] So they agree that they're just going to be friends.

[670] They will turn to each other for advice on their various businesses for the time being, but there's not going to be any formal relationship.

[671] It was also quite convenient of Warren to do this because he knew that the FCC rules were such that they would not let anybody be on the board of multiple different companies that owned television stations around the country.

[672] And Warren's got his eye on another company that owns some television stations, the Washington Post company.

[673] Ah, right.

[674] I didn't realize.

[675] I forgot they had they had gotten into TV at this point already.

[676] Yep, they had.

[677] So his boyhood dream, his paper route.

[678] And the reason he's got his eye on the post is they've just done a public offering.

[679] What year is this?

[680] This is 1971.

[681] 71.

[682] Okay.

[683] So still only like a year or two after he's wound down the partnership.

[684] He's still in retirement mode.

[685] Here's a little early carve out too for anyone who wants an unbelievably good sort of dramatic telling of that IPO and the events around it.

[686] Go watch the post with Merrill Street.

[687] The post.

[688] Oh, it's so good.

[689] We definitely have to do a whole episode on the Washington Post Company at some point.

[690] But suffice to say for now that the story is equally, if not more, amazing than the New York Times company.

[691] The short version of it is that heading into the IPO, the Post has been in the Meyer slash Graham family for 40 some odd years at this point.

[692] The CEO of the Post, but not the chairman.

[693] The CEO is a woman named Catherine Graham, who her story is just probably many folks have heard of her, is just amazing.

[694] Watch the post and we will tell it someday, but she assumes the role of publisher and CEO at age 46 with four children having never worked a job in her life and goes on to become one of the greatest CEOs in American history, you know, sees the paper through the Pentagon Papers, through the Watergate scandal, grows the value of the company enormously.

[695] She was one of the CEOs that Will Thorndeg profiles in the outside book.

[696] So great.

[697] So Warren sees all this from the outside.

[698] He's got the attachment to the post.

[699] The IPO is happening.

[700] And he says, this is going to be my opportunity to come back.

[701] So he reaches out to her initially with an idea.

[702] He wants to tread carefully.

[703] He's very respectful of Kay and the Graham family and what they've built.

[704] He also knows that it's a dual -class share structure.

[705] So they have control.

[706] Like, there's no, no matter how much stock he buys, like there's no, all the decisions in the company are getting made by the Graham family, just like at the New York Times.

[707] So he reaches out with an idea and says, I've heard that the New Yorker, the magazine, is for sale.

[708] Would you be interested in maybe doing a 50 -50 bid JV to buy it together?

[709] And she has no interest in that, right?

[710] Yeah, she has there.

[711] She's like, I'm learning how to be a CEO here.

[712] We're taking the company public.

[713] The Pentagon Papers are happening.

[714] No, very nice to meet you, Mr. Buffett from Omaha.

[715] But thanks, but no thanks.

[716] But Warren's like, it's like, I've gotten.

[717] to know, or I've got my foot in the door.

[718] Two years later, the person who was chairman of the Washington Post company, Fritz Bebe, who I believe was a long -time family lawyer of the Myers and the Grams, he dies and his estate is being liquided, of which there's a lot of poststock in it.

[719] And Warren arranges to buy a 50 ,000 share block from the estate.

[720] which you know has to has to feel underhanded right like if you're the grand family you're like sorry wait who's buying what yeah who with this guy at omaha and he'd also been buying on the open market too and he now owns 5 % of the company so when he's having dinner with murf he's like he's already got his plans in motion here so he writes k a letter remember they've already met he says this purchase represents a sizable commitment to us being Berkshire and an explicitly quantified compliment to the post as a business enterprise and to you as its chief executive.

[721] Writing a check separates conviction from conversation.

[722] I recognize that the post is Graham controlled and Graham managed and that suits me fine.

[723] Huh.

[724] So you already sort of get this beginning of him wanting to be a wonderful, sort of an owner of wonderful businesses without controlling them and leaving sort of family owners in control.

[725] Exactly.

[726] He wants to be a partner to great managers and stewards of generational businesses.

[727] K, nevertheless, probably rightly, is a little spute.

[728] I bet.

[729] You get an activist investor who suddenly sends you a letter and says, by the way, I own 5 % of your company.

[730] Yep.

[731] You're just so great.

[732] It suits me fine that you control it.

[733] It probably also is known at this point the way that he sort of raided the textile mill company of Berkshire Hathaway.

[734] If you go digging on Warren, you can find some skeletons in the closet.

[735] Yep.

[736] So she agrees to meet with him briefly when she's out in Los Angeles.

[737] And Warren's thrilled.

[738] She shows up at the meeting famously looking like Kay.

[739] She's, you know, Kay Graham.

[740] She's like one of the most prominent.

[741] Stately.

[742] Stately.

[743] One of the most prominent.

[744] people in the Washington social scene.

[745] She's probably the most powerful woman in America at this point in time.

[746] Hanging out with presidents.

[747] Yeah.

[748] First name basis with, yes, everybody in Washington.

[749] And Warren shows up looking like, you know, the bedraggled, uh, wrong -sized suit, uh, you know, guy from Omaha from the hills.

[750] And she thinks this is just hilarious.

[751] They hit it off right away in this second meeting.

[752] And she says, you know what?

[753] Maybe this Warren guy isn't so bad.

[754] Why don't you come back out, meet with me again in Washington?

[755] So he comes back out to Washington, shows up right in the middle of the Watergate proceedings, where Kay and her publisher Ben Bradley pulled an all -nighter the night before making decisions about what to publish about Watergate.

[756] But she still makes time for him.

[757] They go out to lunch, and then afterward Buffett presents her with a contract that he's had drawn up that legally binds him in Berkshire that they will never buy another share of the post without the Graham family's permission.

[758] By the way, by that time, Warren already owns 12 % of the company because he's kept buying.

[759] In exchange for what?

[760] Why would he say, just we voluntarily...

[761] Not an exchange for any.

[762] He just really wants to be on Kay's Goodside and he really, really wants to be on the Washington Post board.

[763] And so he's kind of presenting, I think he uses the term, he invokes Little Red Riding Hood and the wolf.

[764] He says, you know, I may look like the big bad wolf, but we're going to take the fangs right out of the wolf.

[765] I'm never going to buy another share without your agreement.

[766] I've had this contract drawn up.

[767] It's kind of funny, but Kay loves it.

[768] And they steal the deal.

[769] She says, well, okay, then, you know, I'll start calling you for advice.

[770] And what Warren really wanted her to say was, why don't you join the board then as a 12 % owner of the company, but she doesn't.

[771] Warren desperately wants to get on the board.

[772] And why is he want to get on the?

[773] Is it an emotional thing?

[774] Or is it, we haven't talked about why Warren views a paper like this as such an incredible business.

[775] Is it worth taking a moment on that?

[776] I think the board thing specifically is probably an emotional thing.

[777] But the paper, yeah, at this point, it's not only the dominant paper.

[778] in Washington, but it's the, you know, one of the foremost publications in the country, if not the world, after the Pentagon Papers and the Watergate scandal.

[779] So it both has that franchise effect in Washington.

[780] I mean, it is the paper for that city, which I think this comes from a little bit of a different story with the Buffalo Evening News, which I don't think we'll get to today.

[781] But Buffett famously referred to being the only paper in town or the biggest paper in town as an unregulated toll booth that you have, where you basically have pricing power and everybody's going to subscribe to the newspaper.

[782] So, you know, it's a license to print money.

[783] So there's definitely his notion of a franchise town newspaper is awesome.

[784] This is one of the ones in the most important town in America.

[785] And now it has this national, international reach, not to mention all of these sort of great characteristics of a media business where you create the content once and then it's infinitely replicatable.

[786] And of course, there's delivery costs, but it's a freaking good business that's wonderfully defensible.

[787] Yeah, and I think specifically on that defensibility of the newspaper part of the business at the time and the winner take -all network effect in any given geography is that if you're able to amass enough readers, it's just like the stamps business, then the advertisers want to be where the majority of the readers are.

[788] And once you get the ad dollars flowing in from the advertisers, then you can offer deals.

[789] It's like the group buying clones in China.

[790] You can offer subscription deals to enough subscribers to grow your subscriber base that you can crowd out all the competition and the market just naturally tips to a single player.

[791] And that's happening in Washington in a large city.

[792] So this is a fantastic newspaper franchise.

[793] All right.

[794] So he's built himself a 12 % position.

[795] He really likes the company.

[796] He wants to get on the board, but he's not on the board.

[797] He's not on the board.

[798] What happens next is like a middle school dance.

[799] It's hilarious.

[800] So he doesn't have the courage to say to Kay in the meeting.

[801] Well, hey, I'd really like to join the board.

[802] And I presented you with this contract.

[803] Instead, he calls up Murph.

[804] And he says, you know, gosh, Murph, I really want to join the board of the Washington Post.

[805] But Kay doesn't seem to be getting the message.

[806] Do you think you could go see her and, you know, tell her how great a guy I am and, you know, that I'm really not so bad.

[807] And I really do want to join the board if she would just ask me. Wow.

[808] So Murphy, Tom goes to C .K. and tells her, and she's like, oh my, well, yeah, I guess it would be nice to have him on the board.

[809] I really respect him.

[810] Well, but I can't really to send him a letter and ask him, like, he should really ask me. So, Warren is like, I'm going to invite K out to, by this point in time, he and Susie have a house in Emerald Bay in Laguna Beach in Orange County in California.

[811] I'm going to invite Kay out to a weekend at the family house in California.

[812] And I'm going to be like, it's going to be perfect.

[813] I'm going to host Kay to socialite, make it perfect for her.

[814] and, you know, at the end of the weekend, then I'm going to make the ask to join the board.

[815] So he's really putting on a show for Kay.

[816] She comes out.

[817] She's a little puzzled.

[818] The whole weekend goes by.

[819] He doesn't ask.

[820] He doesn't ask.

[821] And then on Sunday morning, Kay finally turns to Warren and says, so I hear you want to join the board.

[822] But I'm not sure, you know, I'm waiting for the right time to do it to bring it to my other board members.

[823] And supposedly Warren, you know, looks at her with longing eyes and says, Kay, when is the right time then?

[824] And they fall into each other's arms.

[825] And she says, oh, join my board.

[826] And this is the beginning of a immense friendship between them.

[827] They become incredibly close for the rest of Kay's life.

[828] They go to events together.

[829] They spend weeks at a time together in each other's houses, in each other's apartments in various cities.

[830] It's never been written whether this relationship was purely potonic or also romantic.

[831] Unsure.

[832] But it certainly becomes a amazing relationship.

[833] Warren would stay on the board of the post for most of the next 37 years.

[834] Oh, I didn't realize it was that long.

[835] Yep.

[836] So the 12 % stake that Buffett bought for Berkshire cost 10.

[837] million dollars.

[838] And in 2014, to put a bow on the post investment, Berkshire sells its stake in what is then Graham Holdings, all the rest of the Washington Post businesses after Bezos buys the post itself.

[839] Berkshire sells at stake for $1 .1 billion, which is only a 12 % IRA from the initial $10 million investment.

[840] However, the Post had also been paying dividends all throughout those 40, 50 years.

[841] So I don't have the data on how much Berkshire received in cash flow and dividends from the post.

[842] But suffice to say, it was an excellent investment on Warren's part.

[843] So $10 million for $1 .2 billion?

[844] 1 .1.

[845] Wow.

[846] By that point, it's funny.

[847] It's actually not a big holding for Berkshire relative to everything else they own by the time they, Bezos buys the post.

[848] Yeah.

[849] And, you know, Bezos ends up buying the post, I think, for $250 million.

[850] Something like that.

[851] When that happens in 2014, 2013, 2014, certainly the value of the post during the heyday of the newspapers of the 90s and 2000s was much, much, much higher than that.

[852] And the cash flow that it was spitting off and sending back to Berkshire and other shareholders was significant.

[853] Did you hear, by the way, a little Easter egg that in the annual meeting, one of the questions that Becky Quick from, CNBC was written in by Don Graham.

[854] No, I didn't see that.

[855] Yep.

[856] Don, of course, being K. Son, who would take over, I think he became CEO before her death, and then after her death became chairman and CEO.

[857] Too funny.

[858] All right.

[859] So that's the post.

[860] So let's reset a little bit on time frame and sort of Warren's evolution here.

[861] Everything's not yet consolidated under Berkshire, right?

[862] Like, who was accumulating the shares of the post?

[863] So that was Berkshire.

[864] Okay, but he's got this whole blue chip stamp thing going on.

[865] Yep, and diversified.

[866] And so we've been alluding to the hot water that they get into with the feds.

[867] So right as Charlie's closing down his partnership...

[868] And this is like 75 -ish.

[869] 75, yep, in 75.

[870] He and Warren get a call from one of Charlie's former partners at MTO, Chuck Rickerhouser, who had done the Seas deal for them.

[871] And Chuck says, hey guys, I just got off the phone with the SEC.

[872] And they're considering pressing charges against you for securities violations for this Russian doll, you know, version of corporate structure that you've got going on here.

[873] And he famously tells them Chuck would spend like weeks putting together a corporate flowchart of all these different entities and who owns what.

[874] we'll try and link to an image of it in the show notes.

[875] It's amazing.

[876] There's so many different subsidiaries and subentities.

[877] And he looks at it and he says, there's got to be an indictment in here somewhere, guys.

[878] I don't know what you've been doing.

[879] But I remember reading this when I was doing the research.

[880] And the Buffett image that you know of today, this sort of folksy near benevolent multi -billionaire or multi -deca billionaire.

[881] I don't even know the right phrase for it, would be 100 billionaire if he wasn't donating so much to the Bill and Melinda Gates Foundation, that he was in hot water with the SEC.

[882] Like, it's just the last thing that I would have expected as sort of the Buffett novice before I started doing the research.

[883] What I was reading about this, I was picturing Warren and Charlie, like Tupac and picture me rolling, and the federalis want to see him dead.

[884] And now David Rosenthal, that is an image I can never unsee.

[885] You can never unsee that.

[886] But it's so apt.

[887] literally the feds are like I don't know what's going on here but like I don't like it clue me in it was something to do with the fact that they ended up paying more yeah for something when they could have actually paid less my understanding is I think the feds had sort of been on the tail because Warren especially is you know now becoming so known he's he's he's he's high profile right like he's on the board of the Washington Post like how much more high profile with agencies in Washington can you get So the investigation comes to center on a company called Westco Financial that Blue Chip had bought after Seas, they'd kept looking for other great businesses, and that they'd bought a stake in Westco.

[888] And this is some kind of bank?

[889] It's like a financial services business at this point?

[890] Yeah, it was a financial services business in Southern California.

[891] And what happened was there was another company, I think like Santa Barbara Financial Corporation, or something like that, financial corporation of Santa Barbara, that had a buyout offer for Westco.

[892] And Warren and Charlie thought it was undervalued and had sort of stepped in and scuttled the merger and ended up investing through Blue Chip in Westco instead.

[893] So there was still a stub kind of public.

[894] They basically backstop the price because they're like, look, we hold a bunch of this already.

[895] We're not going to let you buy it for this really cheap per share price.

[896] So we're going to come in.

[897] we're going to lead another investment round effectively in it or buy some more of it at a higher price to make it so that, like, you're not going to get away with this steel that you're coming in.

[898] And so the way it goes down is they, through their work and convincing, you know, the board and the family that owned most of Westco, they convince them to drop the merger.

[899] When the merger drops, the Westco stock falls, of course.

[900] And that's when Warren, and Charlie invest, but they feel bad about tanking the stock price.

[901] So they decide, they work out a deal with the company and with the family that they'll buy shares and invest.

[902] I can't remember if it was at the merger price or maybe even slightly above.

[903] And the feds are like, wait a minute.

[904] There's got to be something shady going on here because like, A, you scuttled the merger.

[905] B, you then could have just bought the stock for lower.

[906] but you paid this artificially high price, what's going on?

[907] Every other time we're investigating someone, what they ended up doing was buying the stock as cheap as possible after they precipitated an event that made the stock price fall.

[908] So they're very confused.

[909] So Warren ends up getting subpoenaed and testifies that they paid the price they did because, quote, it was important how Wesco management feels about it.

[910] Now, you can say, well, we own the controlling interest so it doesn't make any difference.

[911] But Lou Vincente, who was the president of Wesco, he doesn't really need to work for us.

[912] If he felt that we were, you know, slobs or something, it just wouldn't work.

[913] And Munger, when he's testifying, he of course invokes who else but Ben Franklin in his testimony.

[914] He says, we didn't feel our obligation to the shareholders was inconsistent with leaning over backward to be fair.

[915] we have that Ben Franklin idea that the honest policy is the best policy.

[916] It had sort of a shoddy mental image to us to try to reduce the price.

[917] It's almost like the notion of like the VC founder friendly thing where we're saying, hey, look, like let's take a super long lens here and say that the way that we're going to maximize value for everyone, including ourselves, way down the line, is by making sure that management likes us as shareholders and feels that we're, you know, deferential to them and not, not capturing every little bit of value we possibly can out of their company at their expense.

[918] Yep.

[919] And he's totally right.

[920] This is something I'd always wondered, you know, from afar looking at Berkshire, they buy these companies that are, if not wholly family -owned businesses.

[921] Many of them are public companies, but have a large family controlling ownership like Westco, like the, like the post.

[922] They buy these companies.

[923] And then the family or the current management often stays on and keeps working there.

[924] I'm like, why would, why would they do that?

[925] And this is the key.

[926] Why?

[927] Because they're not just trying to like, they're playing the long game.

[928] You know, what they really want is great managers who've built great companies to stay running them.

[929] And the way to do that isn't to negotiate every last dollar out of them.

[930] Or even if it is, like I think some of, I think we're conflating two things here a little bit.

[931] I think Berkshire does make sure they get a great deal when they buy a family -owned business outright.

[932] You know, they, they're good at buy and low, but they either just believe that the business has so much future upside in it, that they're willing to, you know, meet in the middle on price, or they are very good at identifying managers who have a splinter in their mind to continue to do the work.

[933] Like, there's something about, they're very good at this shrewdly evaluating, even if this person no longer holds a single share of their company, are they going to show it for work every day because this is their life's mission and purpose.

[934] And, you know, I'm not totally, I don't think that's what was going on in the West Go financial situation.

[935] But I think when they buy these family -owned businesses, there's a lot of that in the evaluation of the business.

[936] And they, they definitely compensate those managers well for their continued performance.

[937] And I think that was like part of it here, too, because it's almost like this is part of the upfront compensation is the price that they're going to pay for the company.

[938] This whole thing sucks, though.

[939] Like, this is like a multi -year drawn -out thing with the SEC where, like, it's hard for them to get on with their business in every other facet because they have this thing going on.

[940] Not to mention, it's not great for their reputation when they're going out trying to talk to the K -Grams of the world and saying, hey, no fangs here when the SEC is investigating them.

[941] So they end up sort of coming to this gentleman's agreement with the feds where Blue Chip, which had been the primary player in the West Coast saga, although I think Berkshire and maybe diversified were also buying shares too, which was part of the problem, promises not to do it again, something like this.

[942] It's like no admission of guilt, but we also won't do it again.

[943] We won't admit that we did it, but if we did do it, we won't do it again.

[944] And most importantly, Warren and Charlie agreed to start taking steps to, quote, simplify this complicated, rat's nest structure of companies that they have.

[945] So right off the bat, they finally merge Diversified into Berkshire, which they had wanted to anyway, and by this point, Diversified owns a large chunk of Berkshire shares.

[946] Charlie gets installed as the chairman of Wesco to be sort of more arm's length than Warren, and they make it a goal to merge blue chip into Berkshire as soon as all of the remaining kind of legal suits wind up and settle here.

[947] That actually takes a while, but it finally does happen in 1983.

[948] Wow, that really took a while then.

[949] It really does take a while.

[950] Yeah, I'm not sure exactly why, but especially since the SEC wants them to merge it all into one company.

[951] Yeah.

[952] And Warren and Charlie want to as well, for whatever reason.

[953] It takes until 1983.

[954] All right.

[955] So they're making an effort to clean things up.

[956] They've got this SEC thing behind them.

[957] It's the late 70s.

[958] There's another chapter on the horizon.

[959] isn't for Berkshire.

[960] Oh, yes.

[961] Is there ever?

[962] And indeed, it is a chapter involving an old flame, the original crush of Warren's.

[963] I think this is the thing about Warren.

[964] I don't know about his romantic life and situation.

[965] It's certainly also complicated.

[966] There's a lot about that in the snowball and elsewhere, not the scope of our show to get into.

[967] But he certainly has like a serial love affairs with companies.

[968] Well, and somehow there's all these businesses that he has like a romantic flame for from his childhood and from various parts of his life that just so happened to be these like unbelievable businesses where like it's a furniture mart or it's the soda he drank growing up or it's the newspaper he delivered and like investing in each and every one of those proves to be like a once in a generation unbelievable business.

[969] It's almost like big fish in a way.

[970] Like this man's life is just surrounded with these like Six Sigma events of like these really crazy or Forrest Gump or like what are the odds that the smartest guy that the Army ever surveyed or the Air Force ever surveyed in that generation IQ -wise happened to also be born in Omaha and then get introduced to him by work at the grocery store.

[971] It's just crazy.

[972] Yeah, work for his grandpa.

[973] Yeah.

[974] Oh, and it's also funny that like Warren and, I'm more Warren here than I think, Charlie.

[975] he's so smart and so analytical like you know charlie munger thinks he's the smartest person he's ever met that's saying something at the same time warren is also so emotional and nostalgic and has this i think you said it on the last episode this sense of like you know what he looks for in companies and what he absolutely wants to be himself is like viewed as an artist painting a painting so of course we're talking here about guy go All right, listeners, our sponsor is one of our favorite companies, Vanta, and we have something very new from them to share.

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[995] In the intervening at this point, it's like 20 years or so, two decades, since Buffett had tragically sold his Geico steak, the company grew immensely.

[996] it made the acquired, like, growth in its target market when we went from just acquisitions to just telling the story of all great companies.

[997] I was like, where are you going here?

[998] When it moves beyond just targeting government employees to opening up to anybody, non -government employees can also get their auto insurance through GEICO.

[999] And this is huge.

[1000] The problem, though, was that in chasing this growth in this new, market, the tight underwriting and pricing of risk of all of these new customers didn't quite keep pace.

[1001] If you don't remember, one of the reasons why Geico was such a great business was through the customers that they were targeting as government employees for whatever reason or another happened to be much safer drivers than the average population.

[1002] It's a known data set.

[1003] it's a pre -homogeneous group, and, you know, it's a lower risk homogenous group.

[1004] Totally.

[1005] So they didn't really update their pricing enough as they've broadened out to the rest of the population.

[1006] And as we talked about last time, in insurance, there is never any such thing as a bad risk, but there is such a thing as a bad price.

[1007] And the doubly compounding problem for an insurance company, when you've been mispricing your risk over many years is that just like you get the amazing benefits of the float business model where you get the money at front, you get to use the money before you need to pay out claims.

[1008] When you misprice your risk, that whipsawes on you.

[1009] Once you realize that you're going to be on the hook for a lot more dollars than you have capital available, you're in for a long period of pain because the premiums that you got, they're already in the bank.

[1010] You can't go get more money from those customers, but you know that you're now facing years of streams in the future of more money that you're going to have to pay out than you have.

[1011] Yeah.

[1012] It's like you just let someone walk into your casino without testing the game, and turns out the game actually pays out the people who are playing at the casino more than it does to the house.

[1013] Totally.

[1014] And you're not able to change your odds or the structure of your game for a very long time where you can only change it for like new customers you come in.

[1015] Yeah, the analogy breaks down somewhere in here, but yeah.

[1016] It's bad.

[1017] Suffice to say.

[1018] It's bad and it's not getting better anytime soon.

[1019] So in 1976, the company announces a $190 million underwriting loss, the largest in its history, maybe even the largest in like auto insurance history, period at that point in time.

[1020] They eliminate the dividend for the company because they need to conserve all the cash that they can to deal with this.

[1021] And Wall Street figures out, they don't have enough capital to cover future losses.

[1022] So this is like a crisis situation.

[1023] Insurance regulators descend on the company.

[1024] The stock drops from $61 a share to $2 a share.

[1025] Like, do you imagine that?

[1026] You know, what's that like 90 % value destruction?

[1027] You want to get to the exits before anybody else does if you're a shareholder.

[1028] Totally.

[1029] So Warren, unfortunately, hasn't had all of the, cigar butt, Ben Graham, ironically, Ben Graham with Geico, philosophy beaten out of him.

[1030] This piques his interest again in Geico.

[1031] So he thinks he's found another, you know, Amex type situation where...

[1032] Yeah, like, where is Buffett to say that they're going to recover from this, then he's not going to, you know, catch the knife on the way down?

[1033] Right.

[1034] So he wants to find out, can this actually be turned around?

[1035] But unlike the salad oil thing, where it was pretty easy to figure out, like, yeah, this is going to be good.

[1036] Like, that's not going to be the case here.

[1037] There is no way to avoid the years of paying ahead that Geico is going to go through.

[1038] But there is something that Warren sees happening that the rest of the market doesn't quite understand yet, which is that Geico, you know, a good move, fires all of its management team and brings in a new CEO, a grizzled, literally grizzled veteran of the insurance industry who Warren had heard about named Jack Byrne.

[1039] And this guy is a legend.

[1040] And does Warren have anything to do with installing him?

[1041] No, no, no, no. This is, Warren's just watching from afar.

[1042] He's waiting to see if there's something that, like, a glimmer of hope that maybe Geico could make it out of this.

[1043] Because the stock is, like, super attractive.

[1044] I mean, two bucks a share.

[1045] Right.

[1046] So this is their current board, like figuring out what to do here.

[1047] Yep, yep, partially at the, uh, shall we say request of the regulators.

[1048] So they're like, yeah, you guys have really gotten yourself up a creek here.

[1049] So Jack had been one of the top execs travelers insurance before he resigned in like a huff when he was passed over for CEO.

[1050] Wow, that's going to come full circle.

[1051] Totally.

[1052] It's absolutely going to come full circle.

[1053] Listeners, remember traveler's insurance, just so David and I aren't making inside jokes here, like, as we get to the end of the episode.

[1054] So Jack is like, he's the man for the job.

[1055] He comes in and he engineers a plan to go out to all the other auto insurers in the industry and basically argue to them like, hey, if Geico goes under, yeah, you'll lose a competitor, but it's actually going to be terrible for you because, like, if we go bankrupt, all of these underwater policies, the regulators are going to make you guys absorb them.

[1056] You don't want that.

[1057] Oh, man. Was that true?

[1058] Is that what would happen?

[1059] Well, I mean, you can't operate a motor vehicle in America without car insurance.

[1060] So if your insurer goes under, you need insurance.

[1061] And especially if you got claims underway, like what's going to happen to those?

[1062] Like, if the insurance company behind those claims goes away.

[1063] Interesting.

[1064] So this is the argument that Byrne makes to the industry.

[1065] And it mostly works.

[1066] And the deal that he proposes is to get all these other auto insurers not to buy Geico, but to reinsure Geico for some of these future losses off of their own balance sheets.

[1067] And remind us what reinsurance is.

[1068] Well, so reinsurance is anytime an insurer is selling off some of their risk in their portfolio to another insurance organization.

[1069] and there are large reinsurers like Kettle that we've talked about on the show, what are my angel investments?

[1070] All they do is they buy risk off of other primary insurers books, but primary insurers can also buy risk off of each other's books.

[1071] This is like, just to keep bringing it back to Vegas for fun, if a sports book messes up and sets the line in the wrong place, and then they end up like 70 -30 on, you know, are the Patriots going to win or the Buccaneers going to win.

[1072] I can't remember if they were playing the Super Bowl.

[1073] just throwing names out, they will go to another casino and bet the other side to basically make it so that they're sure they're not going to make as much money on a sort of expected value basis, but now at least they're not overexposed on one side versus the other.

[1074] Exactly, exactly.

[1075] In your example, I mean, Tom Brady's going to win either way.

[1076] So that's the bet to make.

[1077] Whichever team currently has Tom Brady is the answer to that game.

[1078] There's probably a way to make that bet somewhere.

[1079] I love it.

[1080] We digress, though.

[1081] We digress.

[1082] So this plan actually, Buffett is like, that's a good plan.

[1083] That's like a creative plan.

[1084] That could work.

[1085] So he gets K. Remember, Guy goes in Washington and Kay knows everybody in Washington.

[1086] So he, Buffett doesn't actually know Jack.

[1087] He gets K to broker an introduction for them.

[1088] They meet at Kay's house in Washington.

[1089] Buffett grills burn for hours.

[1090] And he's like, oh yeah this guy's going to do it so just like the first time that buffett met geico when he goes takes the train down he meets laura davidson and the very next day he liquidates 75 % of his portfolio to load up on geico to impress ben graham the next day after the dinner with burn at kay's house he buys four million dollars of geico stock at two bucks a share so he he loads up he's all in How much of the company is that?

[1091] I didn't actually disentangle that versus what he would buy in what's going to happen next.

[1092] So it's some meaningful percentage, but after what happens next, Buffett's going to end up with a third of the company.

[1093] Right.

[1094] So this is like high single digit, low double digit that he just bought at the company.

[1095] Yeah, probably in the double digits.

[1096] So now, that goes back by Buffett.

[1097] Byrne is the man for the job.

[1098] Things are looking up, but they still need capital to.

[1099] operate.

[1100] Like they're, they're out of money.

[1101] They're going to sell off some of the risk, but they've got claims that are happening now that they need to pay off.

[1102] So they need to go raise money.

[1103] So Buffett tells Byrne to go up to New York and do the rounds with the investment banks and line somebody up to do a secondary equity offering out there.

[1104] None of the big established banks want to touch this situation, except for one.

[1105] There's one bank that is willing to take on enough risk and enough risk to their reputation of what could end up being a broken offering here, which all the, you know, white shoe banks are like, we don't do broken offerings here.

[1106] So I don't actually remember who this was.

[1107] I'm going to guess by the relationship that gets forged for future events that it's Solomon Brothers.

[1108] It is Solomon Brothers.

[1109] Indeed.

[1110] The Bank of Liars Poker, Michael Lewis, Bame, which we will definitely come back to in a sec. They're the only bank that is willing to underwrite what ultimately ends up being a $76 million convertible debt deal, convertible into equity, that they underwrite.

[1111] Buffett flies to New York and tells, and it's not just Solomon Brothers, it's one specific person at Solomon Brothers, guy named John Goodfriend, who is a rising star there.

[1112] Remember that name, folks.

[1113] So, good friend and Solomon underwrite the $76 million deal.

[1114] Buffett flies up to New York to sit down with Goodfriend and tell him, hey, look, I know this is going to be a tough deal to get through.

[1115] Even Solomon Brothers' famous sales distribution channels, even your famous prescriptionists out there.

[1116] If things go sideways, Berkshire, we're willing to underrate the deal and do all of it, but we're going to do it at a much lower price than what you go out with.

[1117] if the deal is broken.

[1118] So everyone's like, all right, great.

[1119] At least, well, I'll go trade on your name then at least and say, tell all my clients like, hey, Warren Buffett already owns a large percentage of this company and he's willing to...

[1120] Okay, so what do you mean trade on his name?

[1121] Like, what do you mean Buffett will do it all but at a lower price?

[1122] Like, he would buy the whole offering?

[1123] Like, if they're trying to sell a whole swath of stock at a certain price, is this the convertible preferred that they're selling?

[1124] Yeah, this is the convertible.

[1125] I think it's convertible debt.

[1126] Not convertible, prefer.

[1127] But, yeah, essentially what Buffett says is he's like, look, I'm good for the $76 million, but I want you to go out there and try and get this deal done at like less dilution.

[1128] It's such a higher price on that convert.

[1129] It's like when an insider in a venture round tells the company, hey, like, I'm good for my pro rata in whatever round you raise, go raise the round, go get a price.

[1130] if you were to lead an inside round, you know, I'd lead it, like if you wanted to do it an inside round, but it won't be at the price where you could go raise your external land.

[1131] Your external round.

[1132] Exactly.

[1133] That's exactly what's going on here.

[1134] So, girlfriend's like, all right, I can work with that.

[1135] You go out, Solomon Brothers, sales and trading, famous, aggressive sales and trading desk, they get the deal done.

[1136] It ends up being oversubscribed.

[1137] And Buffett does end up, even though it's oversubscribed and goes out at the price that they wanted.

[1138] Warren's like, all right.

[1139] I think this company is going to make it.

[1140] He ends up buying 25 % of the deal, even at full price for Berkshire.

[1141] The stock, even though they just issued new convertible into equity, you know, securities, the stock jumps to eight bucks a share because people realize, hey, this is, this is good news.

[1142] This thing could make it out alive.

[1143] And if it does, damn good business.

[1144] Yeah, exactly.

[1145] So, Geico has now got two of the three problems solved.

[1146] It's got, it's capitalized.

[1147] it's got enough money to make it through.

[1148] It's laid off a lot of the tail of risk in their current book over the coming years with the reinsurance deals that they do.

[1149] But it's still not pricing right.

[1150] So the thing about auto insurance and most consumer insurance is you need licenses to operate in any state.

[1151] And part of the licensing process is you have like a license to sell insurance at a certain price.

[1152] You can't just like arbitrary.

[1153] change your price on your customers.

[1154] That's the, the regulators don't allow that.

[1155] It's a super weird market.

[1156] It's not like, uh, you know, we could change the price of the LP show tomorrow if we were.

[1157] You're only allowed to make a certain amount of profit to there's sort of a cap on the profitability of insurance businesses.

[1158] Exactly.

[1159] So this is Burns time to shine.

[1160] This is amazing.

[1161] This is my favorite moment I think of this whole second episode.

[1162] So he goes out to all the states individually.

[1163] He explains the situation and be like, hey, we were mispricing.

[1164] We got to raise prices on consumers.

[1165] And some of the states are okay with it.

[1166] Apparently New York right off the bad.

[1167] It's like, yeah, we get it.

[1168] Okay, fine.

[1169] But some of the states are playing hardball.

[1170] And in particular, New Jersey is playing hardball.

[1171] Huh.

[1172] I mean, New Jersey, right?

[1173] Like, uh, burn himself.

[1174] Yeah, Burn himself is from New Jersey.

[1175] So he's like, all right, you want to, you want to do some mafia tactics here.

[1176] I'll do some mafia tactics.

[1177] So I'm just going to read what has.

[1178] happens next from the snowball because I can't do this any better than Alice didn't care.

[1179] So Byrne marched into the New Jersey commissioner's office with a copy of the company's license to operate in the state in his pocket and told Shearin, the commissioner, that Geico must have a rate increase.

[1180] This is now a quote from Byrne.

[1181] He had a sour ass little wizened actuary at his side who'd been fired by some insurance company and had a bone to pick.

[1182] Shearin said, My numbers didn't justify a rate increase.

[1183] I did all the arm waving and stuff that I could, and Mr. Shearin was intractable.

[1184] Sir Byrne pulled the license out of his pocket, threw it on Shearin's desk, saying, I have no choice but to turn in the license, or something to that effect, with more four -letter words.

[1185] He then drove off to the office with his tire screeching, sent out telegrams to 30 ,000 policyholders in New Jersey, canceling their insurance that day, and fired.

[1186] 2 ,000 New Jersey employees in a single afternoon before Sheeran could go to court and get an injunction to stop him.

[1187] Byrne says, it showed everybody, all audiences, I was serious about this.

[1188] And then I was going to fight for the life of this company no matter what, including walking out of a state, which wasn't done back then.

[1189] Byrne's impalement of New Jersey had exactly that effect.

[1190] Everybody knew he was serious.

[1191] And so do they end up actually just vacating New Jersey and just didn't serve policies there?

[1192] They literally vacate New Jersey.

[1193] They vacate a bunch of other states.

[1194] And By then he's like, look, this is war.

[1195] Like, we're either going to, we got a reprice.

[1196] So either we're going to burn the house down, you know, and vacate these states or we're going to be allowed to reprise.

[1197] So Geico, by the end of this, has shrunken down to only, seven states.

[1198] It's like the original Travis Kalanick.

[1199] I know, I know.

[1200] It's amazing.

[1201] He has shrunken down to only seven states.

[1202] Burn has completely swapped out everybody in the company.

[1203] Famously, a lot of the sort of middle and lower management in the company.

[1204] It was from the, you know, the old days, undisciplined days.

[1205] Apparently at one point, the then existing HR director is giving a speech in front of the company.

[1206] And Byrne gets so upset that he's Storms on stage and fires him on the spot, literally, like, gives him the hook, takes him on stage, points to somebody in the audience and says, you're the new HR director, breaks him up on stage.

[1207] Amazing.

[1208] Is Lorimer still there at this point in history?

[1209] Lorimer is long retired at this point in time, but he's like cheering on from the sidelines that he's advising Burn and Buffett behind the scenes.

[1210] Wow.

[1211] Amazing.

[1212] So they shrink Geico down to only the seven states and D .C. that let them change the rates and they write the ship and they price the policies appropriately.

[1213] The company gets profitable.

[1214] It stops losing money.

[1215] It starts growing again and then would go on to become what did Warren say in the annual meeting this weekend?

[1216] I think that they have like 20.

[1217] Second largest insurance company.

[1218] Yeah, Progressive is slightly larger, but I think they each have about 25 % of the U .S. market.

[1219] Wow.

[1220] Something like that.

[1221] Incredible.

[1222] And he spent $47 million from 1976 to 1980 to buy, is it about half the company?

[1223] So, yes, by the time the debt offering closes, and then when the share price jumps, I assume the debt converts at that point, Berkshire owns 33 % of GEICO, but because he's Warren and because this is now like one of his jewels, he runs the playbook that he's also helping K. Graham run at the post.

[1224] ghost, Geico starts buying back its own stock.

[1225] So by the mid -90s, we're fast -forwarding to, we'll get to this later in the next episode.

[1226] By the mid -90s, Berkshire has 50 % of the company without putting in another dollar.

[1227] And then in 1995, Berkshire buys the rest of Geico that it doesn't own for $2 .3 billion.

[1228] So they get half the company for 47 million and half the company for 2 .3 billion.

[1229] Either way, they get a hell of a deal because estimates are that Geico's worth probably about $50 billion today, maybe more.

[1230] Wow.

[1231] So that's $25 billion of value, assuming that's 50 on $45 billion, and $25 billion of value on $2 .3 billion.

[1232] Either way, pretty good.

[1233] Either way, pretty good.

[1234] Warren's like, look at me now, feds.

[1235] Listeners, even though this is going to be in the final part, of the trilogy, we do have to tell you that in 1996, the $2 .3 billion that was used to purchase the second half of Geico, you might be saying to yourself, why did it take so long if he really liked this business forever?

[1236] Well, Berkshire had a lot of cash tied up in other stuff for a while, and a thing that happened pretty much immediately before this $2 .3 billion transaction for half of Geico was that Warren had a big investment in capital cities, and Disney, came in and bought ABC Capital Cities, which then, of course, in that outright sale, all the proceeds went to Good Old Berkshire, and that was a little bit more capital than $2 .3 billion, but about the same amount that suddenly they had to play with to go put to work somewhere else, and Geico was where they decided to go put it to work.

[1237] What better jewel to put that capital into, than Geico.

[1238] Amazing.

[1239] So, you know, it's funny.

[1240] We said on, or I said, on, the first episode, something that I was totally convinced was right at the time.

[1241] And now maybe not, where I said that, God, if Warren had just held on to Geico had not sold, imagine what his returns could have been.

[1242] You know, who knows what would have happened otherwise.

[1243] But, you know, Geico almost died, right?

[1244] Like, if he had held on, would he've had this ride anyway and ended up here?

[1245] He got to buy back in at two bucks a share.

[1246] Totally.

[1247] Yeah, that's a good point.

[1248] He did get it at an extremely low basis, even though he skipped a few.

[1249] decades of compounding and growing in there.

[1250] It is also worth pointing out that despite the fact that it is a Buffett mantra to hold businesses forever, hold great businesses that you believe in forever, he can dump a stock just as fast as the next guy.

[1251] I mean, the way that he dumped all the airline stocks at probably the low point of the COVID stock crash, it was really interesting hearing him on stage last week where he was totally unapologetic for that.

[1252] Thought it was totally the right move.

[1253] And you could imagine that he easily could have been convinced that that was the right thing to do in the Geico situation, too.

[1254] Totally.

[1255] And all that matters is the long run.

[1256] Although as Charlie Munger would say, who is it?

[1257] I think it's Charlie quoting John Maynard Keynes that in the long run, we're all dead.

[1258] So, you know, but in the long run, Geico becomes, you know, one of the major jewels, if not the most important piece of Berkshire, especially given all the float that they generate.

[1259] I guess that is the big thing that Berkshire and Warren miss over that 20 -year period where he's not invested in Geico is using the float.

[1260] Yep.

[1261] There is a playbook theme I want to pull forward here, which is, and it's actually two themes, and it's important to know how they're different.

[1262] The first one is identifying things that have far less risk than the market perceives them to have, and that's things like American Express, that's things like him realizing that brands are more powerful than value investors give them credit for or the magical thing of a monopoly franchise newspaper.

[1263] But then there's this second category of identifying things that should you act, will have far less risk than the market perceives them to have.

[1264] And even more importantly, if you uniquely have the capability to act, then you actually can be value creative.

[1265] The thing that he did with Geico in making sure that that financing got done, there's not a lot of people out there whose name can be traded on to get an offering done like that.

[1266] And Buffett's willingness to both strategize and then put his name on the line, and of course his name wasn't really on the line, because otherwise he just would have gotten the screaming deal, but did a thing that he was uniquely suited to do and able to do, meant that in a self -fulfilling prophecy way, the investment was way less risky, merely because he was.

[1267] was involved.

[1268] Yep.

[1269] Oh, boy, is that ever, is that ever the case?

[1270] And does Warren ever know it?

[1271] David, I figured I'd set you for that next story we got coming.

[1272] Well, you really, you tossed that ball in the air and I just, I cannot wait to slam it.

[1273] But before we get to Warren getting punched drunk on his own reputation and ability to, uh, to save businesses.

[1274] So all the, the Geico situation wraps up got around 1980 and, you know, it's off to the races.

[1275] The rest of the beginning of the 80s is just more goodness for Warren and Charlie and Berkshire.

[1276] So finally, when Paul Volcker becomes chairman of the Fed, first at the end of the Carter administration, and then under the Reagan administration, he enacts the, you know, correct fiscal and monetary policy to reverse the terrible inflation that have been happening, and the 80s just become, you know, we're both children of the 80s, like an immense period of prosperity, the 80s and 90s for America.

[1277] So the 80s of the go -go years, you know, this is Wall Street movie, this is access, this is everything.

[1278] And it's a good time for Berkshire in Omaha, too.

[1279] So we won't go into all the details, but they buy the Nebraska furniture mart from Mrs. B. incredible story.

[1280] She think it's upset with the way her children who are like in their 80s at this point, or 70s are running the business.

[1281] She leaves, starts a competitor across the street at age 95 when Berkshire has to buy it back for $5 million and sign a non -compete with her at age 95.

[1282] Amazing.

[1283] There's the Buffalo Evening News in here, sort of at the early 80s, which is when Buffett really, is that the early 80s?

[1284] Yep, early 80s, yep.

[1285] He gets it into a good old -fashioned newspaper war.

[1286] He's trying to be the franchise newspaper in the city, ends up sinking tons of capital in, gets into a, not a fight, but a few disagreements and has some words with Charlie about the right things to do.

[1287] But, you know, Buffett's a committed guy.

[1288] There's a bunch of stuff that happens in here that we could do 10 episodes and wouldn't have time for it all.

[1289] Totally.

[1290] He goes to war with the efficient market hypothesis theorists, which is amazing.

[1291] And just like at Columbia's 50th anniversary event of the security, the publishing of security analysis, he gives this talk where he just like, he calls it the super investors of Graham and Doddville.

[1292] It gives this long talk, eviscerating the efficient market hypothesis folks, economists, which basically their hypothesis is that all markets are efficient and that changes in price are simply volatility and around the efficient price.

[1293] and that volatility equals risk.

[1294] And so that is market beta.

[1295] And that's all there is.

[1296] Like, if you're investing, there is no such thing as investing acumen.

[1297] You're just taking volatility risk in the market.

[1298] Charlie has a one word retort to that, which is bullshit.

[1299] Warren goes through and eloquently explains why that's wrong.

[1300] Well, and they just have a lifetime of investment results to prove it.

[1301] Like, they actually can generate alpha.

[1302] How well, like, otherwise you have to believe that Buffett has flipped a coin and it's come up heads, you know, a hundred thousand times in a row.

[1303] Like, you're into these crazy probabilistic scenarios where, you know, at some point, it's too many standard deviations away from the mean for you to believe that it's possible.

[1304] Yeah.

[1305] And the reason this is important for what's about to come is, like, all this is theory, right?

[1306] This is like economic theory.

[1307] But it has a very, very important real world consequence in the 80s, which is that people who, you know, use to their advantage, the academic thinking behind the efficient market hypothesis that risk equals volatility, they realize that, well, wait, if risk equals volatility and you can't get alpha, the way you can get more returns, if you take something that has a certain degree of volatility, and then you lever the crap out of it with debt.

[1308] You magnify that volatility, and then you can magnify your returns if you arbitrage that.

[1309] And so this is when, you know, the 80s are the debt -fueled decade, you know, mortgage -backed securities get introduced.

[1310] All the junk bonds and Michael Milken and DLJ and corporate raiders and corporate takeovers are all happening.

[1311] Massive leverage buyouts.

[1312] You get barbarians at the gate.

[1313] Yep.

[1314] Ardair and Obisco, everything.

[1315] And Buffett and Charlie are sitting and looking at this, and they're like, volatility being risk is nonsensical.

[1316] Risk is risk that you go out of business.

[1317] And introducing debt into the equation, far from not changing your risk, it massively increases your risk.

[1318] Because what causes you to get game over, it's when you go bankrupt and you can't pay off your debt.

[1319] So while they're out there espousing this philosophy, in the meantime, well, they do do the capital cities deal finally with Tom and Dan.

[1320] So Buffett stepped off the board of the post to be able to do the Cap Cities investment.

[1321] The Cap Cities deal.

[1322] So he invest $517 million in Cap Cities to help them buy ABC.

[1323] 517 million.

[1324] Like, I mean, that's a big chunk of money, but he can do this at Berkshire now.

[1325] Like, they're enormous.

[1326] They're a multi -billion dollar company.

[1327] He's a billionaire himself.

[1328] already at this point.

[1329] And so if these guys are anti -leverage and they're trying not to, you know, do the LBO thing where you lever up and then buy something and then have to make debt payments forever out of the profits of the thing that you just bought, how does the Cap Cities transaction work then where Cap Cities is able to be the minnow that swallows the whale?

[1330] Well, a big part of it is that $517 million in equity from Berkshire coming in to the deal.

[1331] I see.

[1332] So they basically have a very large post -money valuation effectively because they're issuing a whole bunch of new primary shares out of Cap Cities to be able to have enough money on the balance sheet to buy ABC.

[1333] So I don't know, I don't have notes on exactly what the structure of the deal was.

[1334] I believe it was some Cap City stock plus the 500 million in equity from, I think it was convertible equity from Berkshire.

[1335] And then they probably did add on some debt as part of it.

[1336] But, you know, like a reasonable amount of debt.

[1337] Like, right.

[1338] Especially with a predictable cash flow business, you know, that that's reasonable.

[1339] Where Warren and Charlie get themselves into not just like trouble on the order of the trouble with the feds earlier in the episodes or actually the multiple troubles with the feds earlier in the episodes.

[1340] But real honest to God, like frankly the worst moments of their lives trouble is when they think that their reputation and their ability.

[1341] to save companies and their ability to be this capital partner to companies is so great that they can come in and save Wall Street itself.

[1342] Or Wall Street from itself.

[1343] Or Wall Street from itself with Solomon Brothers.

[1344] Oh, boy.

[1345] Here we go.

[1346] So remember we told you to remember John Goodfriend and Solomon Brothers, who had helped Geico do the convert deal that Warren backstopped.

[1347] You know, Warren thinks Goodfriend walks on water at this point.

[1348] You know, they're the only bank that was willing to do this.

[1349] Warren famously and Charlie, they famously hate Wall Street.

[1350] They hate banks.

[1351] But like, you know, okay, you did be a solid.

[1352] And we know these guys.

[1353] So we feel for them a little bit.

[1354] They don't seem like the enemy.

[1355] They're kind of our, you know, we know them.

[1356] Yep.

[1357] So we're now in the late 80s.

[1358] Good friend has become the seat.

[1359] of Solomon Brothers.

[1360] They've gone through a series of mergers and acquisitions.

[1361] The firm is much bigger than it was before.

[1362] It's now publicly traded.

[1363] And Solomon already was the debt king.

[1364] But in this environment of the debt fueled, everything we were just saying about the 80s, Solomon is like the king.

[1365] They sold the first mortgage back security, an inglorious honor, if there ever was one, they go deep into junk bonds, derivatives, all kinds of hairy stuff.

[1366] It gets so extreme at Solomon that in 1980, I think it was 86, a young Princeton graduate shows, and aspiring writer, shows up at the firm as a new hire, Michael Lewis on the bond sales and trading desk and ends up writing a book about his experiences intended to be as a car.

[1367] cautionary tale of the wretched excesses of wall street has the exact opposite effect called lyres poker it's inspirational beacon for a generation of of wall streeters to come look i remember reading the book when i was graduating from princeton and about to go work on wall street myself and it's just it's like the social network 20 years later it's like you know this was meant to be at most at best a you know show all sides of a complicated situation and at worst a cautionary tale and instead like a whole generation of young people just look at it and they say like I want me some of that sounds fun you get rich great I'll just read one quote from the book where Lewis writes about the famous 41st floor home of the bond traders at Solomon he says because the 41st floor was the chosen home of the firm's most ambitious people, and because there were no rules governing the pursuit of profit and glory, the men who worked there, including the more bloodthirsty, had a hunted look about them.

[1368] The place was governed by the simple understanding that the unbridled pursuit of perceived self -interest was healthy, eat or be eaten.

[1369] The men of 41 worked with one eye cast over their shoulders to see whether someone was trying to do them in, for there was no telling what manner of man had leveled himself to the rung below you and was now hungry for your job.

[1370] The limit of acceptable contact within Solomon Brothers was wide indeed.

[1371] Here was capitalism at its most raw and its most self -destructive.

[1372] I love Michael Lewis.

[1373] I could make every single one of his books to carve out at some point.

[1374] So great.

[1375] So despite this immense success in the bond market, Solomon and Goodfriend have gotten themselves in kind of a pickle here, because it's working too well.

[1376] All these traders, all these wolves of Wall Street, they are generating so much money, but they're demanding that they're going to get paid all the money.

[1377] So all of it gets paid out in bonuses to all the traders who are constantly demanding more and threatening to leave for other firms, that the corporation itself, the recently public, now public company, Solomon Brothers, the profits are actually declining.

[1378] I was seeing some stat that even in a year, I think it was in a year where they underperformed the S &P 500, there were still over 100 people at the firm that were paid out over a million dollars in their bonus.

[1379] Oh, totally.

[1380] Yeah, one year where that happened, famously, one guy just individual trader, made a $23 million bonus in one year in like 1987 or something.

[1381] Right, which is, I don't know, two X, two and a half X by inflation today.

[1382] Whatever it is, that's a damn lot of money.

[1383] For a rent seeker.

[1384] Totally.

[1385] Where's the value creation there?

[1386] Oh, there is only value destruction happening here.

[1387] There is nothing being created.

[1388] Or certainly value capture.

[1389] Absolutely.

[1390] So because Solomon itself is suffering, they start attracting the attention of corporate Raiders.

[1391] And in particular, Ron Perlman.

[1392] Revlon, right?

[1393] Yeah, Revlon.

[1394] Yeah, he buys out Solomon's existing largest shareholder, and he starts agitating.

[1395] Like, he's going to take over Solomon Brothers, which good friend of nobody at the firm, because they just want to keep paying themselves the bonuses.

[1396] They, of course, don't want this.

[1397] So you've got basically the 100 % most anti -Buffet and Munger, at least what they say, situation possible here.

[1398] A bunch of people at the firm, management, quote unquote, there's no management.

[1399] going on, but like employees, just simply enriching themselves at the cost of shareholders while ratcheting up risk in the economy and creating no value.

[1400] What could be better?

[1401] Good friend calls Buffett.

[1402] He's worried about he doesn't want to get thrown out by Pearlman.

[1403] And he says he needs to cash in the favor from the Geico deal.

[1404] And Warren, you know, Berkshire has such a reputation of being the white knight and saving companies at this point that.

[1405] And being management friendly.

[1406] And being management friendly.

[1407] Exactly.

[1408] It's all going to come back to bite them that good friend says like, hey, if I can get Warren to join the board, I'm going to get Pearlman off my rear end.

[1409] So Warren and Charlie agree to do it.

[1410] And they both take board seats, right?

[1411] They get two seats.

[1412] They both take board seats.

[1413] So here's how it goes down.

[1414] It's Rush Ashana weekend in September 1987.

[1415] And Pearlman is like a Orthodox Jew.

[1416] So he's out of commission.

[1417] He's not.

[1418] He's not doing anything over the weekend.

[1419] And good friend knows this.

[1420] And so he times everything.

[1421] So he gets the deal done in secret with Buffett and Berkshire over that weekend.

[1422] Berkshire buys $700 million of convertible preferred stock in Solomon.

[1423] So more than the money than they put into Cap Cities with a 15 % interest rate coupon on attached to that convertible preferred stock.

[1424] So it's like the company's in dire straits and the CEO really doesn't want or really does want to incentivize these particular shareholders to become shareholders.

[1425] Well, that's what's so disgusting about this situation is like the revenue line essentially of the firm has never been better.

[1426] Like these traders, you can say what you will about what they're doing, but they are raking in money at the top line.

[1427] But then they're paying it all off to themselves in bonuses.

[1428] so the firm is suffering.

[1429] Capital's coming in.

[1430] They do this really tough terms deal simply to save, you know, again, quote -unquote management's own skin.

[1431] It's really something that goes on here.

[1432] I mean, it's crazy that Warren and Charlie and Berkshire do this.

[1433] Even, you know, loyalty is super important to them and good friend and Solomon having saved get -go.

[1434] Anyway, they do it.

[1435] Both of them.

[1436] joined the board.

[1437] And there's this famous scene where they fly to New York, the two of them over this weekend.

[1438] This must be like on the Friday.

[1439] And they go to the Solomon building to sign the papers and good friend takes them on a tour.

[1440] They go to the balcony overlooking floor 41.

[1441] It's like a call back to child Warren overlooking the balcony of the stock exchange and being like, well, there's so much money here.

[1442] I want me some of that.

[1443] And they're looking down on what's essentially like a seething gladiator pit below.

[1444] And Charlie looks at Warren and he says, so you really want to invest in this, huh?

[1445] And Warren supposedly just is kind of like silent for a minute.

[1446] You can just see him being like, what am I getting myself into?

[1447] And he finally says, mm -hmm, in like a slow.

[1448] And then he goes and signs the papers.

[1449] And, you know, credit to Charlie for asking the question, but Charlie follows him to the pit too.

[1450] And - Oh, 100%.

[1451] And joins the board as well.

[1452] Totally.

[1453] And probably regretted it every day after.

[1454] So they do the deal.

[1455] This is September of 1987.

[1456] October 19th of 1987 is Black Monday when the Dow falls 22 .6 percent.

[1457] Oh, my God.

[1458] And essentially a flash crash.

[1459] I had this confused in my mind.

[1460] I thought Black Monday in 87 was the long -term capital management thing.

[1461] No, that happened much later.

[1462] This was actually a flash crash.

[1463] So like nobody really knows why this happened.

[1464] Of course the market was overheated.

[1465] Of course there was way too much leverage in the system.

[1466] But things recover pretty quickly.

[1467] That's not what triggers a meltdown.

[1468] So Solomon, of course, gets crushed like the rest of Wall Street.

[1469] They lose $75 million in trading losses on that day.

[1470] The stock gets crushed.

[1471] But they're not in any better or worse shape than any other investment bank.

[1472] but the stock is swayed down.

[1473] So Buffett and Munger show up to their first board meeting after this happens, which is like the next month maybe in November.

[1474] And good friend in management puts a deal on the table to reprice all employee's stock options because the stock is down.

[1475] And Buffett and Munger flipped.

[1476] They're like, wait a minute.

[1477] You guys lost a ton of money for the firm.

[1478] like we as you know as shareholders in the firm like our stock that we just invested our 700 million is now worth less and you guys are saying you want to take advantage of this lower stock price to reprise all of your options that you're then just going to trade out of immediately as soon as they vest and liquidate for cash right it's it's like you know no one here wants to become bigger owners of this thing you all just want a quick arbitrage opportunity exactly exactly but they acquiesce you know they don't really want to fight with management.

[1479] And they also know that if they get into kind of a public fight with, if this becomes public, that they're fighting with Good Friend and the board.

[1480] Stock price drops even further.

[1481] Stock price is going to drop even further.

[1482] They've got $700 million at stake here.

[1483] And so they don't really want to do that.

[1484] So, I mean, we're already pretty far down the slippery slope here.

[1485] This is when the real slide starts.

[1486] So not only do the options get repriced, but then in secret behind the board's back, good friend reaches a deal with the head of the best performing trading desk on the floor, the so -called magical arb desk, the bond arbitrage desk, run by John Meriwether, who runs the domestic fixed income arbitrage group, to directly pay them 15 % of all the trading profit they make as bonuses.

[1487] So like, no longer even just to like, hey, management will decide your bonus at the end of the year.

[1488] It'll be based on the performance of the firm.

[1489] It's now like you're a prop shop.

[1490] Like 15 % of all of your profits, you're going to take home with none of your own capital at risk and on the hook for none of the downside when you have losses.

[1491] Wow.

[1492] I'll incentivize some bad behavior.

[1493] Yeah.

[1494] So things limp along for the next couple of years.

[1495] Warren and Charlie aren't thrilled about everything that's going on.

[1496] But so then the shoe drops.

[1497] In August of 1991, Buffett is on vacation in Reno, Nevada, and he gets a call from, not from Goodfriend, from Solomon's president, Tom Strauss, and its general counsel, Don Furstein, who behind the scenes at Solomon, Don is referred to as, quote, the Prince of Darkness for all of the dirty work.

[1498] Things I never want to be called.

[1499] Yeah.

[1500] That he, all of the sticky situations that he gets Solomon out of and all the dirty work he does.

[1501] This is amazing.

[1502] You can't make this stuff up.

[1503] So Warren's on vacation.

[1504] He gets a call.

[1505] This is not a call you want to get.

[1506] And so Warren's suspicious.

[1507] They get on the phone and they're like, well, our firm's outside counsel, Solomon's outside counsel, has figured out that the head of our government bond trading desk, Paul Moser, who reports to Maryweather.

[1508] he's apparently been violating some of the Treasury Department's rules when bidding on government bond auctions.

[1509] The way the Fed controls the money supply, the way that interest rates are set, they bid out bonds, government debt, and then all the big investment banks get to place bids in terms of interest rate, and then the government selects which banks buy the debt.

[1510] And there's only a few, what is it, 40 banks or something that are even allowed to be involved in these options, that are allowed to have the privilege of buying debt from the U .S. government.

[1511] Yeah, this is the way the money supply gets into the economy.

[1512] To be one of these banks means that you are controlling, you have a direct relationship with the federal government and the treasury controlling the economy.

[1513] So, Moser's been violating the rules.

[1514] They don't say exactly how or why, and that they've suspended him and Solomon is going to, you know, notify the regulators about this.

[1515] And Warren's like, oh, the Prince of Darkness is calling me for this.

[1516] Like, That doesn't seem that bad.

[1517] Like, you violate some rules, okay.

[1518] But, like, while this is really important and prestigious, this is, like, kind of a sleepy part of the firm.

[1519] You wouldn't think that the government bond desk is something that could, like, blow up the firm.

[1520] You know, you'd be more worried about the ARB desk, per se.

[1521] So he's like, all right, well, you know, call Charlie.

[1522] He's the lawyer between us.

[1523] You know, he'll know what to do.

[1524] Just some rules.

[1525] Like, how bad could it really be?

[1526] I'm sure it's just some regulatory tape.

[1527] Some regulatory stuff.

[1528] So they're like, oh, yes, we've, we've already talked to Charlie.

[1529] He's totally cool with it.

[1530] Like, no worries.

[1531] So Warren's like, okay, great, I'm going to go back to vacation.

[1532] Well, turns out Charlie wasn't totally cool with it.

[1533] And turns out that maybe Moser did a little bit more than just violate the Treasury's bidding rules.

[1534] What he actually did was he submitted fake bids on behalf of clients for the treasury auctions, both fake bids for real clients and fake bids for fake clients.

[1535] So on behalf of people who weren't even customers of Solomon Brothers.

[1536] And his goal in doing this was to essentially corner the market in this auction win all of the auction for these treasury bonds and put the squeeze on all the other participants who needed the bonds to sell to their resell to their clients so that he could then sell it at a massive profit in the market, which he did.

[1537] And of course, while it's illegal to bid on behalf of your clients who are not placing orders and that it's even more illegal to bid on behalf of imaginary clients, it's also illegal to try and quarter the market on a given auction.

[1538] There are rules in place that say things like you can't try and bid for more than 35 % of any given auction because, we need it to be able to be spread around because we don't want this big second market for people paying a big premium because someone managed to go get 90 % of the allocation.

[1539] Totally.

[1540] And the reason they don't want this to have happened is what actually happens as a result of Moser's actions like three or four small financial firms that couldn't absorb this price volatility go bankrupt.

[1541] So this is like, this is real what the dude did.

[1542] And I think he did this like four or five times.

[1543] And the net of all of it was Solomon made an incremental $4 million in profit.

[1544] All of this for $4 million.

[1545] So it turns out he did it multiple times.

[1546] It turns out that Meriwether, who was his boss in the chain of command, and Goodfriend knew about this four months ago, and they knew about it because the SEC started investigating and got in touch with them.

[1547] And when that happened, the general counsel, the Prince of Darkness, told Goodfriend that what was happening here was criminal, but that technically, they didn't have any technical obligation to report it to anyone.

[1548] The CEO is sending letters to the general counsel without notifying the board.

[1549] Like, hey, I got this letter from the SEC.

[1550] They're investigating us.

[1551] But just our GC needs to know about it.

[1552] Yep.

[1553] not notifying the board, notifying the shareholders of the public, and equally, if not worse, notifying the other regulators that this is going on.

[1554] So the SEC is investigating, but they haven't found any.

[1555] They just found some irregularities.

[1556] Internally, Solomon found, oh, no, this is criminal.

[1557] Like, what's going on here?

[1558] So they don't tell anybody.

[1559] And not only that, they don't fire Moser.

[1560] They leave him in place running the government bond desk.

[1561] and there's no audits or controls on what he's doing.

[1562] So basically they're like, don't do that again, wink, wink, wink.

[1563] Wow.

[1564] And then they turn around and look the other way.

[1565] So at this point in time, the SEC has like figured out like, yeah, these aren't just irregularities.

[1566] They figured out what's going on where it starts to get out.

[1567] On Monday after this August 12th, the Wall Street Journal runs a big piece about how bad this could be and how little is known.

[1568] Solomon's counterparties, their lenders and their trading partners, start, like, getting cold feet about dealing with Solomon and all the markets that they operate in.

[1569] And Solomon, it turns out, they're the second biggest bank on Wall Street at this point in time.

[1570] They have 150 -150 billion of capital, like, in the markets.

[1571] Wow.

[1572] But they only have $4 billion of equity.

[1573] All the rest of it is, like, short -term paper and debt and leverage and, like, like everything that has been building up in the 80s.

[1574] So they're like, what's that 60 times levered on their capital?

[1575] And all of a sudden, their counterparties start getting cold feet about trading their paper.

[1576] And 50 billion, 5 -0 billion of the 150 billion rolls over every single day.

[1577] That's really short -term paper.

[1578] So if there's a problem, it's going to be instantaneous and the firm is dead.

[1579] So also on that same day, on that Monday, this is probably the worst thing that happens.

[1580] So the Federal Reserve sends a letter to Good Friend and Solomon saying, I think only Good Friend and the general counsel see this, saying that it is, quote, deeply troubled by both the firm's actions and lack of actions, and it is questioning whether it can continue to have a business relationship with Solomon brothers.

[1581] This is the Federal Reserve, unless the firm responds to this letter, and significantly changes its business practices within the next 10 days.

[1582] Now, if the Fed ends its business relationship with Solomon, game over.

[1583] Like, it's dead.

[1584] All the counterparties are going to stop trading with Solomon.

[1585] Wow.

[1586] Like, it's literally game over instantaneously.

[1587] Good friend and the GC just sit on the letter.

[1588] They don't tell the board.

[1589] They don't tell anyone else.

[1590] They don't tell the Cheryl.

[1591] Nobody knows about the letter except the two of them.

[1592] The feds assumed that the letter.

[1593] the board knows about the letter that like Solomon is doing something.

[1594] But good friend and the DC cover it up.

[1595] Buffett by this point in time, he gets in touch with Charlie and Charlie's like, yeah, you should be concerned about this.

[1596] So the board convenes, they issue a press release saying that, you know, they're looking into this and figuring out what happened.

[1597] The firm's stock drops 30 % that day.

[1598] The Fed, meanwhile, is like, you guys aren't responding to our letter.

[1599] Like, they're just getting angrier and angrier every day that goes by.

[1600] On Friday of that week, the New York Times runs a headline, Wall Street sees a serious threat to Solomon Brothers.

[1601] And the Fed finally has had enough, the lead investigator running the case at the Federal Reserve, calls Goodfriend and says, you need to resign like today.

[1602] And you need to install new management or else, you know, essentially.

[1603] When Goodfriend gets that call, he calls Buffett, who's still in Omaha.

[1604] and he essentially just tosses him the keys to the firm.

[1605] And he's like, I'm going to resign.

[1606] Somebody has to step in and run the place and deal with this.

[1607] And it's probably got to be you.

[1608] So good luck with that.

[1609] Wow.

[1610] Not quite in that language, but that's essentially how it goes down.

[1611] Pretty intense stuff.

[1612] Warren and Charlie are legitimately frightened at this point.

[1613] And the argument there is like, hey, I have to be out.

[1614] We don't have any ideas for who's next.

[1615] Yep.

[1616] There's no plan.

[1617] There's no management.

[1618] Whoever steps in has to have the reputation to be able to save this firm.

[1619] And like nobody wants their investment to go to zero.

[1620] So I pick you as the person who seems like you might be able to save this thing.

[1621] Well, at this point, the fiduciarily responsible people are the board.

[1622] And who are the most prominent people on the board, Warren and Charlie and Warren specifically.

[1623] So like, you know, good friends already out as CEO.

[1624] So there's nobody left except Warren to come in and deal with this.

[1625] So Warren immediately gets on a plane to New York, and he goes and meets with the Federal Reserve and tries to like understand it.

[1626] So we talk to them.

[1627] This is amazing to me. The Fed, I think, assumes that Warren knows about their letter, but he doesn't.

[1628] And that wires still get crossed in this meeting.

[1629] So Warren doesn't understand what the worst case scenario really is.

[1630] and cryptically at the end of the meeting, Buffett's trying to, you know, sweet talk them and buy more time, the Fed tells Warren that to quote, prepare for all eventualities, i .e. that they're going to yank the right to, you know, participate in the treasury auctions and Solomon's going to go down the tubes.

[1631] So now it's Friday night into Saturday morning and Warren has to make a choice.

[1632] He can walk away from Solomon, say I'm resigning.

[1633] And $700 million goes up.

[1634] in flames.

[1635] But he can walk away.

[1636] Or the other option is he can take the reins of the company and try and steer this thing through.

[1637] As he's thinking about and talking with Charlie, he realized he actually doesn't have a choice because if he walks away, his reputation is toast.

[1638] If he walks away, 100 % his reputation is toast.

[1639] And like, he loses 700 million.

[1640] Like, that'll be fine.

[1641] But like, what company is going to do a deal with Berkshire Hathaway ever again after this?

[1642] Right.

[1643] And And if he stays, you know, probably there's a good chance he's not going to be able to navigate through this, in which case his reputation is also toast.

[1644] Which this brings up that George Bernard Shaw quote that I think it's Charlie who likes to quote it, never wrestle with a pig.

[1645] You just get dirty, but the pig enjoys it.

[1646] Exactly.

[1647] And like you can imagine that moment where they're standing out looking over the trading floor knowing that they're about to wrestle with a pig and then this is the eventuality of what happened with that.

[1648] Yeah.

[1649] And this is where, as he's realizing this, so Alice writes in The Snowball, quote, At some point during that long horrible Friday, he recognized with a sickening jolt that investing in Solomon, a business with problems over which he had essentially no control, had put it all at risk.

[1650] And by all, she means everything, not just the 700 million in Solomon, like everything that Warren and Charlie together have built.

[1651] you know, they're both on the board.

[1652] So he decides he has to take the job.

[1653] He decides he's going to become interim chairman of the company.

[1654] And he installs the head of the investment banking division, a guy named Derek Amon as the CEO.

[1655] That's just kind of like a big, I mean, the investment bank is, that was the one thing that Solomon was not good at was the investment banking advisory at business.

[1656] So he gets installed simply because he's just far away from all the toxicity.

[1657] And then, On Sunday, the board, Warren and Charlie and the whole board is at the office in New York.

[1658] They're trying to figure out what to do.

[1659] When a letter arrives from both the Federal Reserve and the Treasury Department, they haven't heard any response to their deadline of things have got to happen.

[1660] And thus far, nothing has been announced from Solomon.

[1661] So they say they've had enough.

[1662] It's the end.

[1663] Like, no more negotiating.

[1664] They're pulling the plug that afternoon.

[1665] And by the time the market opens in Tokyo, which is like, I think late afternoon, New York time, this is Sunday afternoon.

[1666] So Monday morning, Tokyo time, it's going to be announced that the Fed has revoked Solomon's licenses and it's over.

[1667] So Warren directs the board and the lawyers to start preparing a bankruptcy filing.

[1668] And in the meantime, he desperately starts trying to call anybody he knows in the government using all of his Washington connections to like try and stay the execution here.

[1669] And he finally reaches the Treasury Secretary Nick Brady, which is the Treasury and the Fed jointly made this decision.

[1670] And Warren literally like breaks down on the phone crying and like begs him, says this is the most important day of my entire life, begs him to stay the execution and just give them like a little more time and figure things out.

[1671] And so Brady is like, moved by this.

[1672] If I literally Warren Buffett, you know, if there's anybody in the world who could get the government to change its mind, and he says like, okay, let me go talk to let me go talk to Greenspan the head of the Fed and figure out what we're going to do.

[1673] So hours go by.

[1674] It's all in limbo.

[1675] And they're just sitting in the Solomon office drafting up a bankruptcy filing.

[1676] And then a call comes in, from the assistant treasury secretary.

[1677] Do you know who that was at the time?

[1678] Call comes in for Buffett.

[1679] No. One Jerome Powell.

[1680] Oh my God.

[1681] Then assistant secretary of the treasury.

[1682] Incredible.

[1683] And he says, look, this is bad.

[1684] We're not going to allow Solomon to bid itself in treasury auctions anymore.

[1685] so we are going to like we need our pound of flesh we will however because of you Warren because you're stepping in and you're committing to making changes we will allow Solomon to continue to place bids on behalf of its clients and he says will that work and Warren is like that'll do whoa yeah so he literally gets the government to reverse their decision unbelievable.

[1686] Oh, that's insane.

[1687] So now they have to deal with the aftermath.

[1688] Also, it's incredible that Goodfriend never showed the letter because I assume he was a shareholder too.

[1689] And of course, it's going to come out that there was a letter sent at some point.

[1690] So it's not like he's saving himself any legal liability by not disclosing it.

[1691] Well, I think what happened, I don't know how far in advance he had gamed this out.

[1692] What ends up happening, I'll tell the story in a minute of how this all wraps up.

[1693] But as this is going down like concurrently, that weekend.

[1694] Good friend and his lawyer, they end up, because Warren still, he doesn't know the extent of good friends, you know, deception here and cover up.

[1695] And he doesn't know about the letter.

[1696] He doesn't find out about the letter until later.

[1697] And so they go out to dinner.

[1698] And good friend and his lawyer, a personal lawyer, try and get Warren and Charlie to sign a severance package for him leaving the company.

[1699] They want a $35 million payout.

[1700] your reaction is priceless there that's wild isn't that wild so they're trying to get the money as always and um fortunately you know they're dealing with charlie munger here so charlie basically stonewalls them he this is amazing i don't have the quote written down here but this would later get arbitrated and charlie would testify in the arbitration under oath that charlie's natural way of, you know, being with other people is he turns his brain off when he's not interested in things and he wasn't interested in what they had to say.

[1701] And so he was just muttering and not saying anything.

[1702] It's amazing.

[1703] In the negotiation?

[1704] Yeah, in the negotiation.

[1705] So they don't agree to anything.

[1706] They don't sign anything.

[1707] And ends up after years of fighting this in arbitration, get zero dollars, as he should.

[1708] Anyway, so they get the save, the stay of execution, from the government, and then they have to deal with the aftermath.

[1709] So Warren has no interest or ability in actually running day -to -day Solomon Brothers, but what he can do is he can deal with the government and the public.

[1710] So he instructs Mon, the new CEO, to clean up the firm inside.

[1711] You handle everything inside the building.

[1712] And his instructions are get it right, get it fast, get it out, in terms of dealing with all the corruption in Solomon.

[1713] And basically the first thing that happens that week is he gets, Warren gets summoned before Congress to go testify in front of Congress.

[1714] And this is brilliant.

[1715] So they bring in MTO, Munger, Tolson, and Olson, of course, to represent him in all this.

[1716] And Roy Olson comes in.

[1717] And Roy suggests this brilliant step that goes a long way, I think, towards saving Warren and Solomon.

[1718] He suggests that they proactively go to the government.

[1719] government and say, we will waive our attorney -client privilege.

[1720] So everything, which is, this is like extraordinary.

[1721] This never happens.

[1722] So they're going to the government and they're saying all of our communications and anything that MTO finds at Solomon, we will share with you.

[1723] Wow.

[1724] And it makes sense to do that because they're the new guard.

[1725] So it doesn't, there's no way it can reflect poorly on Warren, Charlie, MTO, it's only going to be negative for all the people that Warren wants to fire anyway.

[1726] Exactly.

[1727] So Alice writes in the snowball about how perfect this was.

[1728] The more evidence that MTO found on employees that were guilty, the more proof it would show the government that Solomon was cooperating and that Buffett was cleaning everything up.

[1729] And the employees, meanwhile, must cooperate or be fired since none of anything that they would say would be protected by a tyranny client privilege with MTO.

[1730] So the employee's options were get fired or answer MTO's questions, and anything you say to MTO is going directly to the government.

[1731] Yeah.

[1732] So Warren's not there to protect anyone.

[1733] He's there to, uh, this is a win -win for him.

[1734] Exactly.

[1735] Exactly.

[1736] This has Charlie's finger prints all over it.

[1737] Huh.

[1738] So Warren goes in front of Congress, probably one of the most famous statements that Buffett's ever made and, you know, certainly corporate history, where he's being grilled by senators about what he's, he's going to do at Solomon and how he's going to turn it around.

[1739] And he says, the way that Solomon's going to operate going forward is lose money for the firm and I will be understanding, lose a shred of reputation for the firm, and I will be ruthless.

[1740] Hmm.

[1741] Fascinating.

[1742] And he kind of puts on a show and he wows Congress.

[1743] And Solomon ends up getting out of this thing with, they settle in the next few months with the government for a $190 million fine plus a $100 million restitution fund, which I assume is maybe to go to the other financial institutions that were hurt by the cornering of the market in the treasury auctions.

[1744] Restitution, it's got to be it.

[1745] Yeah.

[1746] Certainly that's a lot of money, but like, this is amazing.

[1747] He pulls this out.

[1748] The firm survives.

[1749] And so obviously Solomon is, you know, damaged.

[1750] But over the next few years, they recover and they end up a few years later.

[1751] And when does Warren, when's he able to like actually step out a day -to -day?

[1752] As soon as possible.

[1753] Basically, as soon as the settlement hits, he's like, and I'm out as chairman.

[1754] He stays on the board, though.

[1755] He keeps the investment in.

[1756] And, but he's no longer day -to -day.

[1757] So this happens in 92.

[1758] Six years later, in 98, Solomon gets acquired by Citigroup, the former traveler's insurance as you put up in for $9 billion, which means that Berkshire gets a return of $1 .7 billion on their $700 million investment plus the 15 % coupon that they had been cash coupon that they've been getting.

[1759] So unbelievably, I mean, it literally takes Warren and Berkshire to the brink.

[1760] But the sense of being a really good investment for them.

[1761] Wow.

[1762] It makes so much sense why Buffett then had the quote, it takes 20 years to build a reputation and five minutes to ruin it.

[1763] If you think about that, you'll do things differently.

[1764] I bet he sort of imagines looking out on the trading floor when reflecting on how he might do things differently.

[1765] Totally.

[1766] I do wonder if he looks back on this and thinks, was it worth it for that investment return?

[1767] Probably not.

[1768] A hundred percent not.

[1769] Yeah.

[1770] A hundred percent not.

[1771] You know, the irony.

[1772] is like 100 % not, but this only kind of adds to the myth of Warren and Berkshire.

[1773] Right.

[1774] Now he's the guy, he can save even the cesspool of Solomon Brothers.

[1775] You know, what can't he do?

[1776] What can't he do?

[1777] Uh, so this is where we're going to leave part two, but there's one coda before we do.

[1778] Ben, you may know, you probably know, but listeners, I will ask, Do you know what other organization, after this whole debacle, that John Meriwether, the head of fixed income trading at Solomon Brothers, would go on to found two years later in 1994?

[1779] David, is it something that had a crisis where you mentioned it earlier in this episode?

[1780] Yes, it would be.

[1781] My God, this is just crazy.

[1782] Is he part of the group that was the former Solomon Brothers people that went to do long -term capital management?

[1783] Not only was he part of that group, he was the leader of that group.

[1784] Literally John Meriwether, founder and CEO of long -term capital management.

[1785] Wow.

[1786] And he was the guy between Good Friend, who was the CEO, and the guy directly underneath him, was the guy doing the auction violations.

[1787] Wow.

[1788] Yep.

[1789] How crazy is that?

[1790] Did any of these guys ever go to jail?

[1791] The only guy who went to jail was Paul Moser, the guy who did the auction violations, and he went to jail for four months.

[1792] Isn't that unreal?

[1793] Wow.

[1794] Like, literally, I mean, the thing that we didn't talk about in this history, you know, certainly the government was influenced by Warren's reputation and his pleading.

[1795] But they were also scared, too.

[1796] nobody knew what would happen if you just took the second largest investment bank in the world out back and shot it like it for sure would have created a financial meltdown and then of course you know 16 years later we got to that was this was the dress rehearsal for what we got to see actually happen in 2008 wow which of course berkshire also uh was an active participant in yeah mostly mostly in buying the dip yeah But, wow, we'll save that story.

[1797] It's funny, we've got, for part three, we'll have the whole tech bubble, we'll have 2008, we'll have the tech bull run of the last however many years and kind of the future of where do we think Berkshire goes from here.

[1798] But this feels like a good place to leave this part.

[1799] Yeah.

[1800] I mean, we intended this to be one episode on Berkshire originally.

[1801] And it's like the deeper we go into it as we were doing the research.

[1802] I mean, this Solomon episode, I knew this.

[1803] that this had happened.

[1804] I didn't know that this had happened.

[1805] No, I mean, the only thing that I really knew was that Warren Buffett was called on to act as the head of Solomon Brothers when they were under duress, and his reputation alone was what saved it.

[1806] But, like, that is really true.

[1807] Like, that alone, it's not just like that he was acting as the head of the bank in a riskless way.

[1808] Like, he risked the whole future of Berkshire to make this happen.

[1809] Yeah.

[1810] In fact, when you think about the return, turning $700 million into $1 .7 billion over how many years was that, like $6 or $7?

[1811] I think he made it.

[1812] It was a billion.

[1813] So I think it was $700 million in and then $1 .7 out.

[1814] But he got the coupon payments also.

[1815] So it's maybe like a 200 % return over six, seven years.

[1816] So good, but not for this risk.

[1817] Yeah, no, definitely not for this risk.

[1818] Wild.

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[1849] Well, I think before we talk about power, we should do a quick review of the businesses that they had owned outright during this part of their history.

[1850] Because I think people have a general sense of the stuff that they own now, both through the businesses that they own wholly and through their ownership of big public companies like, you know, Kraft Heinz, or of Coca -Cola, but let's review the things they bought in the 70s and 80s and owned outright.

[1851] Seas Candy, Westco Financial, the Buffalo News, Precision Steel Warehouse, Nebraska Furniture Mart, thanks to this B, Scott Fetzer, Feckheimer Brothers, Borsheim's Jewelry, H .H. Brown, Central States Indemnity, and then in 95, the finishing touch on Geico, they bought Helsberg Diamonds and R .C. Wiley Home furnishings.

[1852] So there's like a lot of Berkshire that you think about today that they don't own yet.

[1853] Yeah.

[1854] On the public equity side, the main positions we talked about the Post, Cap Cities, Solomon Brothers, and one that we didn't talk about that we'll talk about more next time in Coca -Cola.

[1855] I think those represented significant parts of the value.

[1856] But again, as we've seen, they're taking a hands -off approach here.

[1857] As we analyze the past, we think about them as sort of two different business lines.

[1858] Because it does feel like the business activities day -to -day are very different between those two things, which actually you see reflected in the management structure of the business, flashing all the way forward to 2020, you have Ted and Todd on the sort of investment management side, buying publicly traded companies or investing in publicly traded companies, and you've got Greg and Ajit on the wholly owned subsidiary side.

[1859] The insurance and Ajit running the insurance.

[1860] businesses and Greg running all the non -insurance businesses.

[1861] Non -insurance, which is funny because it's like so diverse that you don't have a way to label it.

[1862] So it's just insurance and non -insurance.

[1863] So, okay, let's talk first about the wholly owned businesses.

[1864] So the business activities there are prospecting, you know, identifying the whole landscapes of businesses you could buy, evaluating those businesses on their fundamentals, you know, making the decision to invest or not invest, and then making sure that you leave or install the correct management in place.

[1865] to make those businesses hum over a long period of time.

[1866] And then, of course, capital allocation where you're making sure that you're deciding if that business is one that you like consuming capital and you want to funnel more capital to that business so it can reinvest in growth, or if that's a capital producer and you maybe like your jacket linings business or your stamps business, you don't want that business consuming any more capital.

[1867] And that should just spit off capital that gets sent to the head office for reallocation.

[1868] So with that preamble, those are sort of the business activities of the wholly owned subsidiary side of the business.

[1869] Now, of the Hamilton Helmer Powers, which basically enable you to, in a long -term way, get a durable, sustainable, differential profits above your nearest competitors.

[1870] So here I think we should think other conglomerates.

[1871] We should think private equity firms.

[1872] Definitely private equity firms.

[1873] Yeah.

[1874] Think about These companies going public.

[1875] Spacks weren't really a thing yet, so that wasn't an option on the table.

[1876] Strategic acquirers, I think, were, though.

[1877] The question is which of the seven powers sort of applies to Berkshire?

[1878] Yeah, this is going to be fun.

[1879] Because it's not network economies.

[1880] It's not our usual favorite.

[1881] It is definitely not.

[1882] I'll make a first run at it and say counter positioning, and certainly counter positioning versus anybody that's running money.

[1883] Yep.

[1884] And I think to more finely articulate that, I opened this episode by talking about the fact that Warren shows a very unique structure in choosing not to have a fund or a partnership, but instead to have this operating business, Berkshire, that he uses the capital from to invest off the balance sheet.

[1885] And it's very interesting when you have that structure and you're not generating fees and you're not thinking about raising another fund.

[1886] and you're not getting a carry or a promote, you have just as much downside risk as upside benefit.

[1887] And so your incentives are pure in a way.

[1888] You only want to make financial decisions that, you know, buy low, sell high or buy low, hold forever.

[1889] And there's no other way that you make money.

[1890] Well, your only focus is long -term value creation because nothing that you're going to do is it going to increase your fees or increase your value in any set, you know, fund life period of time or anything like that.

[1891] Right.

[1892] So that makes you counterposition to private equity firms.

[1893] Yep.

[1894] And so then the question becomes, is that actually power in a positive way?

[1895] Or is it somehow negative?

[1896] Is it just a disadvantage?

[1897] Are they counterposition to you?

[1898] Because let me put it this way.

[1899] There's certainly deals that a PE firm would do that Warren would do because the price is too high.

[1900] But is the opposite true?

[1901] Can Warren get deals done because the PE firms have an opposite business model?

[1902] Well, it's interesting, right?

[1903] Because this is so obviously not a tech company in so many ways.

[1904] And this market that Berkshire operates in, the market of acquiring and investing in other companies is not a winner -take -all market.

[1905] So what's interesting is like, to succeed, they need a niche.

[1906] And they certainly carve out their niche exceedingly well with counter positioning versus other players.

[1907] The best, you know, we didn't talk about this on the episode.

[1908] I'm going to say because we didn't have time, but like, what is time on an acquired episode anymore?

[1909] But this is how they win the Mrs. B deal, the furniture mart deal.

[1910] You know, Buffett sits down with Mrs. B and says to her, because she has other offers.

[1911] to buy the furniture mart for more money and says, you know, you can certainly take those offers and I'm not going to pay what the private equity firms and others will pay.

[1912] But at the end of the day, those firms are what's motivating them is selling your business for more money.

[1913] And they may say lots of things to you and be aligned and love you and want to keep you and your family in place running it.

[1914] But at the end of the day, they're going to do anything to maximize them selling the business for more money within a set period of time so that they can make their fees.

[1915] I'm not going to do that.

[1916] I'm genuinely going to leave you and your family to run this.

[1917] Right.

[1918] It's like having a longer lens is actually the counter positioning here.

[1919] Yeah.

[1920] And simultaneously holding true the belief that, or holding it to be true, that keeping the family in place to manage it is the long -term value -maximizing decision.

[1921] Yeah.

[1922] Both of which are true.

[1923] Both of which can be true, depending on if you acquire the right business.

[1924] It gets back to the fight with the efficient market hypothesis theorists and the nature of debt, which all of the private equity firms are using to buy these companies to lower up the companies and buy them.

[1925] If the goal is to have the companies operate sustainably the longest and generate the most cash flow over truly the long.

[1926] longest period of time, you don't want to use debt because debt is going to increase the chance that the company is bankrupt.

[1927] And so if as a seller, if you care about the legacy of the company, either for, you know, whatever your family working in the business, you know, then making money, you retain a part of it, or just for the legacy of the business, your interests are aligned with Warren's then because he wants the cash flows over the longest period, which means he's going to avoid debt.

[1928] Such a good point.

[1929] Hmm.

[1930] Okay, so yeah, I agree.

[1931] Counter -Positioning, for sure.

[1932] Definitely.

[1933] Definitely.

[1934] I mean, like, that's probably actually the place where you start.

[1935] Like, the Warren Buffett brand just enables you to do things that, like, literally the Solomon thing.

[1936] Like, anyone else crying on the phone to the federal government probably wouldn't have impacted them, but because it was Warren's brand crying on the phone.

[1937] Totally.

[1938] It's right, but I'm trying to use the Seven Powers language here.

[1939] 100%.

[1940] I think the seven powers actually apply a lot.

[1941] Yeah, counter positioning apply, but yeah, branding 100%.

[1942] Like Warren Buffett and Berkshire Hathaway's money is worth more than the equal amount of money from somebody else.

[1943] Yep, absolutely.

[1944] Okay, so I don't think there's necessarily scale economies.

[1945] I mean, maybe you could argue a little bit that like the scale of the insurance businesses and the float enables more investing, which enables more operating businesses, which you know, maybe I think that's a little bit of a stretch during this phase so it's interesting today I think they actually have dis -economies of scale because they just have too much capital that they need to put to work but we'll save that for the next episode I do think uh this period was the one for the first time where they did realize some economies of scale where there is this like nice middle ground where like if you're really small then you can't invest enough money to have sharp elbows on a board but if you have too much money then all you can buy is apple and nothing else moves the needle for you enough.

[1946] But during this period in the 80s, they had like the perfect amount of money where they could be activist investors on boards and throw their weight around and that would deliver enough return for them to be needle moving.

[1947] Yeah.

[1948] Actually, that's a really good point.

[1949] That's a good point.

[1950] It's a power right now, but it's not a like sustainable power.

[1951] Yeah.

[1952] Oh, that's interesting to think about.

[1953] Okay, I don't think they're switching costs.

[1954] No, and that's all I've got for this so far.

[1955] The question is which of those apply to the public investing side of the house.

[1956] Oh, well, the one I was going to talk about, I always have such a hard time thinking about this power.

[1957] And as Hamilton says, it is the trickiest of the seven powers.

[1958] But is there process power here at Berkshire?

[1959] I mean, it's funny.

[1960] It's like thinking about process power in a super small organization feels like a de facto no. Because the always uses the example of the Toyota production system that like the system was so complex, it couldn't be written down to be retought to someone else because it's held in so many heads and the decisions are all made by one person.

[1961] So, like, is there process power in Warren's head?

[1962] Well, he calls Charlie, but Warren ultimately makes the decision.

[1963] I think there's a liberal interpretation of process here to make that the case.

[1964] It's funny, because for public market investing, I was thinking, like, that might be the only really arguable one.

[1965] You freaking efficient market hypothesis to you.

[1966] Well, no, I'm definitely not an efficient market hypothesis disciple, but I do, I think there are definitely market inefficiencies, as this episode shows.

[1967] But I don't know that Berkshire had any sort of unique, any defensible ability versus others to see and then act on them.

[1968] They acted on the ones that they saw.

[1969] Other people could act on the ones that they see.

[1970] Right.

[1971] But getting back to that point that I made earlier around.

[1972] identifying things in the market that not only have less risk, but actually exclusively have less risk than the market perceives them to have when you act.

[1973] I think I was sort of foreshadowing power there where there are things where Berkshire uniquely could have acted and therefore save the company, gotten the deal that they did, were able to join the board, whatever the thing is.

[1974] And so I'm trying to figure out how to quantify that.

[1975] So Wapow, Solomon Brothers, these were things that Buffett could uniquely do in an advantaged way versus their competitors, their competitors being all other capital.

[1976] And why?

[1977] Well, Wapot was kind of, Buffett had to fight his way in.

[1978] It was sort of like maybe that was like part of developing this power.

[1979] Because, you know, Kay was sort of like scared of him at first and certainly reluctant.

[1980] And then Buffett fights his way in.

[1981] I don't know that, like, that was a power.

[1982] But then once he was on the Washington Post board and, like, the mystique of Warren Buffett had started to, you know, grow, then I think maybe it becomes something defensible.

[1983] Yeah.

[1984] That's a great point.

[1985] Well, normally here I would move us on to Playbook.

[1986] I literally think we had discussed every playbook theme during the narrative, during history and facts that I possibly could have brought up here.

[1987] So I have nothing to add in the playbook section this episode.

[1988] Yes.

[1989] As Charlie would say, no. Nothing to add.

[1990] Value creation versus value capture?

[1991] Let's do it.

[1992] So Buffett definitely created more value in this chapter than in the previous one.

[1993] 100%.

[1994] For the previous one, you're buying and selling, you're buying at low prices, you're selling at high prices.

[1995] Here you're doing things like they legitimately created value for Solomon's shareholders.

[1996] Like a lot of it.

[1997] They created $9 billion worth of value.

[1998] The question is, what other situations in the 70s and 80s did they create value?

[1999] Certainly for Berkshire shareholders by marrying the insurance businesses and the operating businesses for Berkshire shareholders to be able to sort of realize the incredible benefits of those two things operating in tandem.

[2000] I think they also created value for Geico in the saving Geico.

[2001] Now, Jack Byrne did all the legwork himself, but no question having Warren, you know, they're both with the regulators and the government of like, hey, Berkshire Hathaway is behind us now, we're going to be okay.

[2002] But then also specifically with the financing and with Solomon Brothers and with Wall Street, you know, backstopping the deal.

[2003] Yep.

[2004] Is there value destruction for the American consumer by making it so all those people who had Geico in the states that they decided to pull out of lost their car insurance?

[2005] Hmm.

[2006] That's a good question.

[2007] I don't think so.

[2008] I mean, how hard is it to go get different insurance?

[2009] Right.

[2010] And if Geico wasn't going to make it if they didn't make those changes.

[2011] Right.

[2012] It's not like they corporate raidered it and went in and it was going to go, perfectly fine, but then they destroyed it, Toys R Us style.

[2013] Now, what was interesting in that story, though, was, you know, I think Geico and Byrne were the first to actually pull out of states.

[2014] Like, nobody had ever done that before.

[2015] So they did sort of cross a Rubicon.

[2016] So yeah, I don't know.

[2017] That's a good question.

[2018] Now, certainly Solomon brothers, you could debate a lot of value destruction there in aggregate.

[2019] Oh, from the entire time they were shareholders, certainly.

[2020] Yeah.

[2021] Now, did Buffett and Berkshire...

[2022] Meaningfully contribute to that?

[2023] No, probably not.

[2024] Other than they did prop up corrupt management.

[2025] Yeah.

[2026] Like value capture, to move onto that and hit it real quick, it's Berkshire, it's Buffett.

[2027] They always do a damn good job of capturing the value they create.

[2028] No qualms there.

[2029] Yeah.

[2030] Interestingly, especially over this period and the life of the company, probably because of the long -term focus on not -selling investment.

[2031] with regard to tax liabilities, you know, Berkshire and its shareholders pay, if you don't sell, you pay no tax.

[2032] Right.

[2033] Massive tax deferrals.

[2034] Massive tax deferrals, yep.

[2035] All right, grading.

[2036] I want to grade this the same way that we graded the last one, which is we are going to look at their pure performance versus the S &P 500 during that same time frame.

[2037] And you may recall that in the Buffett Partnership years, the annualized return was a 29 .5 percent annual return over those 12 years.

[2038] Historic, legendary.

[2039] And I think what would we determine that was something like a 28X?

[2040] And you actually, that 12 years, you could comp nicely against a venture fund and say, if anyone could 28x the money, then they'd be a top decile fund for sure.

[2041] And the Buffett Partnership had the increased benefit of you could take all your money out or put all your money in in any given year.

[2042] You didn't even have to lock it up for the entire life of the fund the way that Avenger Fund does.

[2043] So, you know, slam dunk, I think we call that an A or an A plus.

[2044] This set of years, we're going to look at 1970, so the year immediately following the liquidation of the partnership to 1992.

[2045] And we're going to look at just Berkshire Hathaway over that stretch of time.

[2046] Their rate of return pretty similar, 27 .4%.

[2047] Dang.

[2048] Like, I don't know how you like the Buffett Partnership years and don't like these.

[2049] I think this is like, like, Yeah.

[2050] This is the golden years of Berkshire Hathaway.

[2051] Totally.

[2052] Wow.

[2053] I didn't realize that that's what the number was.

[2054] I mean, it literally is, it's just like Michael Jordan, you know.

[2055] He went out at the top of his game.

[2056] He came back and he won three more championships.

[2057] And then he went to play for the Washington Wizards.

[2058] And actually, maybe we will see that last part here in, a little bit of foreshadow.

[2059] In the next chapter, yeah.

[2060] But truly, I think there's this.

[2061] scary thing where you sort of look at this and you're like, maybe Buffett does know how to time the market.

[2062] Like, no one can.

[2063] And yet, the guy liquidated his partnership in 69, bought back in big in 71, 72, had this run all the way through, you know, the early 90s, started piling up cash in the 90s.

[2064] And as we'll talk about, wrote a very famous article in 99, you know, the year before the dot -com bubble burst, articulating exactly how overheated.

[2065] everything was as he was piling up his cash.

[2066] So he is acting on his thoughts here.

[2067] Maybe he can time the market.

[2068] Maybe.

[2069] Although, well, we'll save this per part three, but I would say track record on market timing has not been great of late.

[2070] No. But just to put some numbers around this 27 .4 % rate of return, if you had bought Berkshire in 1970 on January 1st, which is the day that Buffett distributed it out to everyone when he closed down the partnership.

[2071] It was 45 bucks a share.

[2072] And at the end of 1992, and of course, these are what we now call the A shares.

[2073] In 1992, that was $11 ,750 a share.

[2074] Wow.

[2075] That's bonkers.

[2076] Bonkers.

[2077] And today it's over $400 ,000.

[2078] Is that right?

[2079] Yes, it is a record high as of last Thursday and maybe up again.

[2080] getting this week.

[2081] Wow.

[2082] My hat is off.

[2083] What more can you say?

[2084] All right.

[2085] What more can you say except like the comparison is Michael Jordan?

[2086] Yeah.

[2087] Well, listeners, we will know more in part three.

[2088] And thank you for listening to the Empire Strikes Back episode of the Berkshire trilogy.

[2089] David, do you want to do quick carve outs?

[2090] Yeah, let's do it.

[2091] So my carve out is a great podcast episode on the Armchair expert podcast, which is so good.

[2092] So good.

[2093] Dax and Monica do such a good job.

[2094] So many good episodes recently.

[2095] But Seattle Love, the McLemore episode was amazing.

[2096] Have you listened to this?

[2097] No, I haven't.

[2098] Oh, you got to listen to it.

[2099] It's so great.

[2100] Lots of Seattle talk.

[2101] Dax love Seattle.

[2102] He recently was in Seattle.

[2103] They spent a lot of time talking about it.

[2104] But McLemore was so great.

[2105] they just get into so much great stuff, lots of discussion about that just ever, just go listen to the episode.

[2106] It's fantastic.

[2107] All right.

[2108] Just added it to my queue.

[2109] Literally pulled out my phone and added it to my overcast queue.

[2110] Mine has its roots in something that you said earlier this episode.

[2111] You mentioned the mafia.

[2112] You mentioned the state of New Jersey.

[2113] I, for the first time, am watching The Sopranos.

[2114] And it is excellent.

[2115] And I totally see how it kicked off this like modern golden era.

[2116] of TV that we have going on and I think it was lost on me I mean I was what nine when it first came out or 10 when it first came out but it was lost on me all these years where I've loved shows like Madman and billions and succession and going back and watching the wire like the Sopranos really did sort of kick it all off and it's violent it's horrifying in many ways but God is the writing great so great so can't recommend it enough I am in season 6A, so I am nearing the finish line, so nobody spoil it for me. Amazing.

[2117] What year did The Sopranos start?

[2118] I want to say it was like 97, 98.

[2119] Wow.

[2120] It was like right around the time The Matrix came out.

[2121] Wow.

[2122] Oh, man, that's a throwback.

[2123] Yeah.

[2124] The Matrix.

[2125] Wow.

[2126] And they share a couple of actors between The Matrix and that, which is, it's old enough where you see people who you know from things later in their career, and you're like, oh my God, it's a young so -and -so.

[2127] And I'm feeling quickly like my parents.

[2128] Like when I was a kid, I remember watching things with my parents.

[2129] And they would say, oh, my gosh, this movie has young so -and -so in it.

[2130] And that's now me. That's amazing.

[2131] That's amazing.

[2132] Well, we're hitting that time of life.

[2133] We are.

[2134] Well, listeners, if you want to talk about all things acquired this episode, things we missed, things we caught, little notions that you have that we may not have seen in the research.

[2135] This is a three -parter, so it is not too late to tell us, and we can insert these great tidbits into the final part of the trilogy.

[2136] Join us in the Slack, Acquired .fm slash Slack.

[2137] You can talk to lots of other people.

[2138] There's 7 ,000 people plus David and I, and it's always a great time in there, so you should join us.

[2139] If you love Acquired, I want to be a deeper part of what we do here, become a limited partner.

[2140] Acquired .fm slash LP.

[2141] You'll get access to our library of over 50 interviews and deep dives on company building topics, monthly Zoom calls, and our upcoming next book club with Brad Stone, which we're super, super excited about.

[2142] So with that, if you aren't subscribed, and you want to part three, someone sent you this, and you're like, I have to make sure I know when part three comes out.

[2143] You can click subscribe and the podcast player your choice.

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[2145] and tell your friends, share it on social media.

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[2147] So thank you for sharing the show.

[2148] Thank you for listening.

[2149] Listeners, we'll see you next time.

[2150] We'll see you next time.