Berkshire Hathaway Part II

Transcript from https://podmenti.com/t/51d622a51173a8a5

Yes.
How many grams of sugar are in this?
Normal
looking size bottle of cherry coke.
Is that twenty ounce?
It is twenty ounce, yep.
Uh
Forty.
Nope.
Fifty.
Seventy.
In a twenty ounce bottle there's seventy grams of sugar.
Mm.
Seventy grams of sugar.
In one twenty ounce bottle.
Wow.
I can't believe they still sell this stuff.
Welcome to season eight, episode six of Acquired.
The podcast about great technology companies and the stories and playbooks behind them.
I'm Ben Gilbert, and I am the co-founder and managing director of Seattle-based Pioneer Square Labs, and our venture fund.
PSL ventures.
And I'm David Rosenthal and I am an angel investor based in San Francisco.
And we
are your hosts.
On our last episode, we told the story of Warren Buffett in the years of running his own partnerships, those twelve years leading up through nineteen sixty nine to
When he shut it down after his best year ever and returned all the money.
to his investors.
Today we will pick up right where we left off, tell the story of the declining suit liner manufacturer that he bought.
Berkshire Hathaway.
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 we've only briefly mentioned so far.
Charlie Munger.
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.
Unfortunately, you should know David and I better than that.
We were foolish to think that we could tell the whole Berkshire story in a mere two episodes.
So this episode is our Empire Strikes Back.
It will serve as a bridge between the early forces that made Warren.
And the mature Berkshire that we have today.
What made Buffett start investing again after dissolving his partnership?
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.
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.
So here we are.
Part two.
of our Berkshire Hathaway trilogy.
This really is the Empire Strikes Back. It's gonna get dark at the end.
Truly. Be prepared.
There's a little bit of an apt analogy there. It's true.
Well, folks.
Are you an acquired Slack member yet?
If not.
What on earth have you been waiting for? 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.
You can join at acquire.fm slash slack.
All right listeners.
Now is a great time to talk about a new partner of ours here on Acquired, Lagora.
The agentic operating system that is redefining how the world's best legal teams work.
Yep. It's sort of obvious that AI is gonna completely change the legal industry. I bet most of you listening have dropped a contract into some sort of AI chatbot out there. Ligora took that insight and asked the question, what if you really built something with that power from the ground up for the legal industry?
So the founders did exactly what great founders do.
operate with obsessive customer focus.
They embedded inside a massive law firm.
For months.
They sat with the lawyers just watching how the work really gets done.
And that's how you get features that customers love, like tabular review where you
Drop in a folder of hundreds of contracts and it pulls every key term into a grid a lawyer can actually work with. Legor's Bethere is interesting, since it lets each lawyer handle more complexity, any given person can increase the quality of their work and do higher value work. And this means that the pie can grow even as each individual task takes less time.
And they recently launched Lagora Agent, offering greater intelligence and performance. The agent lets lawyers set an objective. Then it can handle the planning and the execution and delivery of the final product. Legal teams get to maintain full control and transparency since they're still involved where judgment is required.
And Lagora works where you already work. You can use it within Microsoft Word while redlining or drafting. The early Lagora numbers essentially
speak for themselves. When they have a head to head pilot with their top competitor, they win seventy percent of the time.
Lagora now has over a hundred thousand lawyers on the platform from twelve hundred legal teams in fifty countries.
And crazily, they went from one million

In about
Eighteen months.

truly insane numbers. And that is the real test.
Plenty of things demo well, but the question is whether a busy associate actually reaches for it during crunch time, or whether a partner trusts it before going into a conversation with a major client.
If your legal team wants to check it out, whether you're a law firm or you're in-house at a company, you can learn more at Lagora.com/slash acquired.
And just tell'em that Ben and David sent you.
Now lastly, if you aren't an L P
You should become one.
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. Our next book club will be with Brad Stone.
who famously wrote everything store, the upstarts.
And now, David, what is his new book?
Amazon unbound.
Part two of the Amazon story.
Just like this is part two of the Berkshire story. So our new format for the book club will be that David and I are going to interview Brad, and if you're an LP, then you you get to join on the Zoom as well and we'll have time for Q and A. And uh everybody will hopefully have read the book before we do the interview. So
You can join at acquired dot fm slash LP and learn more about that program.
All right, David, before you take us in and listeners as always.
This show is not investment advice. David and I may and I think we've already told you that we do
have investments in the companies that are discussed on this episode in this show is for educational and entertainment purposes only.
All right, let's get to it. We got a lot to get through here.
Yep.
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.
So before we pick back up with that story, though, I think we have some unfinished business.
And a character that we need to introduce here.
This is like so, David, even in
an episode where we've already told you like a
a multi decade history and where like into part two somehow you're finding a way to wind the clock back.
Indeed. And we go all the way back to
New Year's Day.
On nineteen twenty four.
In Omaha, Nebraska.
The very same woods that Warren is wandering in.
That sounds like six years before Warren was born. Yep. Six and a half years before Warren was born. Where
You know, Maha.
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 US district court appointed by
Teddy Roosevelt himself.
Thomas Charles.
Munger.
So Charles Thomas Munger, named for his grandfather, Thomas Charles Munger.
And he takes after his grandfather in
Many ways his grandfather makes a big impression on him.
Thomas's mantra in life was concentrate on the task immediately in front of you.
And control your spending.
Sort of sounds similar to Ernest Buffett. Similar ideals.
And this kinda instills this idea of
Gaining wealth through controlling your spending and focusing on doing a great job at the task in front of you and young Charlie.
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.
He has a quote, he says, I wanted to get rich so I could be independent.
Like Lord John Maynard Keynes. Of course elementary school age Charlie Munger is aspiring to be like John Maynard Keynes. So this is where he's a little different than
War and they really have the same.
Aims and goals in life.
But their sort of their styles around it are very different. Warren is just like
I don't want anybody telling me what to do.
Charlie's like, Oh, I want to be like Lord Keynes.
So as we chronicled in part one.
Charlie actually goes to work for Ernest Buffett at the grocery store.
As a kid.
Unbelievable for Warren's grandfather.
Just like Warren learns.
He hates manual labor and
being paid a pittance of salary and he thinks there's gotta be a better way.
He can use his mind.
to make money rather than his uh manual labor.
And
Speaking of his mind, he loves to read. His parents give him and his sisters lots of books. He tears through them.
And uh
Very early in life he stumbles across
Ben Franklin.
And Ben Franklin would become his
hero in life, and that's where he develops this idea. 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.
He decides he
Enjoys more the company of
dead people and learning from them through their books than people who are actually alive. Kind of a one way conversation, but there's probably a lot a lot of wisdom there.
Not to mention like revisionist histories and survivorship bias, yada yada yada.
I think a lot of conversations with Charlie are one way conversations. Uh, as we shall see.
So also Lake Warren, he's he's kind of a wise ass as a kid and has a very high opinion of himself.
His neighbor, one Ed Davis, who we discussed in part one, the doctor,
is his father Al's best friend. And and just as a refresher, uh the Davises would become
one of the first families to invest in Buffett's first partnership, right? Yeah. 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. I think they gave him a hundred thousand dollars.
Because Warren reminded them of the
Surely.
So
He ends up going to
Michigan for undergrad. Sorry, Ben.
It's all right. These days I'm not sure there's much of a rivalry anyway.
Burn. Burn, of course.
Then went to
Ohio State.
So where at Michigan he majors in math.
And gets turned on to physics, where he becomes really entranced with physics.
And then while he's still at Michigan.
Pearl Harbor happens and
The U S enters World War Two.
Uh Charlie joins the air force.
And as part of the intake process, they measure his IQ.
And he's literally like one of the top IQ scores.
That the military and like any branch has ever tested. No major surprise there.
Yeah, no major surprises. It's probably the the you know
Top wise ass uh decile as well.
That is definitely true.
So they send him
first to the University of New Mexico to study engineering there. He then goes on to Caltech
In Pasadena and Los Angeles.
and continues his engineering studies there.
And then
Uh I think he ends up.
If I remembering this right, I don't have it in my notes. I think he ends up
Getting stationed in Alaska.
As a meteorologist.
During the war. I I remember him being in Alaska too as part of his uh his duty. Yeah. So anyway, after the war
He decides that
Yeah, he really
enjoyed learning about engineering and physics and math and all that, 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.
So
Charlie being Charlie, he applies to Harvard Law.
Despite the fact that he
doesn't have an undergraduate degree.
Yeah, he didn't actually graduate from any of these institutions.
And uh he gets in and he goes to
Harvard Law he
Does very well there. Graduates by beta cappa.
And he decides after graduation he's thinking about going back to Omaha.
But he decides.
Well one.
Pasadino is.
It's really nice when I was there.
Caltech. Yeah, the weather in LA is hard to beat.
But also in typical Charlie fashion, he sort of asked himself a rhetorical question.
He's like
Eh w where can I be somebody? And you know, Omaha's uh obviously uh
Right, a rising town, great city, but but it's not Los Angeles. He says, What city is 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 Ricks.
And it's 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. It was like how much money will I have on the scorebo when I die?
And like I'm sure no matter where I live, that'll get compared to everyone else. And for Charlie it was, you know, we're gonna be a man about town and that town should be big enough to be
worth being a man about town. And it's also funny to me that at this point, like LA is
for him something that he views as like, Oh, it's not too big yet.
Yeah.
Well, it wasn't I mean, right after World War Two
Obviously it was a big town and Hollywood had always been there, but it w I think California, in particular Southern California
experienced a huge population boom.
After World War Two.
Of which.
Charlie was part.
So
Very tragically, after moving to LA, 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 LA.
And
Much more tragically.
His son Teddy.
is diagnosed with leukemia. And in those days
There was no effective treatment for leukemia.
Yeah, just tragic. It was
Totally tragic. And
Teddy would end up passing away.
In nineteen fifty five, at age nine,

Unimaginable to
lose a child at all, let alone
In that way and at that age.
Charlie's reaction to this I I think is
Very characteristic, very telling of who he is.
He's obviously absolutely devastated.
But he decides that the thing to do is
is he needs to set new goals for himself and move forward versus being consumed by grief. So he says
After uh 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 uh
It's probably, you know, sound advice, not that I can imagine going through that.
That's also some incredible compartmentalization. I mean if 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 or
Catastrophes.
It's all sort of only something you can decide and tell yourself.
Yeah. And I think only if you are a person like Charlie.
Like Charlie.
So he sets two
Very specific goals for himself.
One to find a new spouse.
And two, to diversify his business activities outside of law. And so on.
Uh I thought this was so funny.
He's really worried. He's now a divorced man and his
thirties and in California, he doesn't know that many m people out there. 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.
So he happens on
A foolproof strategy.
He decides.
That he's gonna do the most rational thing possible.
He's gonna start
Every day scanning the divorce and obituary notices in the paper looking for widows and recent divorce days. Oh my god. I I guess uh I guess there weren't dating websites back in those days. So
That's what you had to do. His friends are kind of alarmed by this.
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
Uh two smart shoes.
Quite smart.
She was recently divorced.
She was five beta kappa from Stanford undergrad in economics. She actually had an undergrad degree, unlike Charlie. And most importantly, C, she took nobody's crap, including
Charlie's.
So
They
Each of the two of them have two children, two surviving children from their previous marriages.
They get married.
They go on to have four more children together.
For an entire
Munger.
Clan of
Ten people, eight children and two parents.
It's a lot of Mongers.
That is a lot of mungers and uh if you see
Photos of them.
uh of the Munger Clan to this day, especially with all the grandchildren. It is
Impressive. It's like a small city.
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.
Uh yes, her name.
Yeah, they're both named Nancy.
Like Yeah.
In in some ways you're like, Come on, that's pretty lazy. Like you can't go marry someone again with your same
Someone once made a remark that Charlie was so sort of absentminded and and forgetful of names that thank God his uh his second wife was also named Nancy, or he would have forgotten her name too.
Yeah.
Very Charlie. He is unique.
So on goal number two
He's doing very well as a lawyer in LA. As you can imagine, Charlie is in
Excellent, attorney.
But he decides that uh
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 in particular one of his clients is the
mining magnet Harvey Mud.
who helped build Caltech into what it became and then
helped uh build and found all of the Claremont Colleges, including the one that
Where's his name?
Harvey Mud.
He was one of Charlie's clients.
So what does Charlie do? He starts
buying some stocks himself, but he also starts taking
Some of his fees from his clients in equity in addition to cash.
Yeah, he's like a he's like the early, you know, Silicon Valley, you know, uh entrepreneurial start up lawyer type that takes some takes some equity in addition to cash for doing the deals.
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.
He gets his net worth up to about one and a half million.
Dollars by the early sixties.
Which if you remember from
Part one, he's like right neck and neck with
Warren.
At this point.
In time.
And that's what, like ten, fifteen million today?
Yeah. So it's certainly more than
Anybody would need to be
Living the good life of a man about town at this point.
Right. And you could imagine like someone in their mid thirties, like you could kinda just live off that interest forever if you wanted to put it into fixed income and, you know, kinda call it.
Totally, totally.
Which
Unlike Warren.
Charlie's not necessarily against something like that. He's definitely
Enjoying himself in LA.
But
Along the way, as we alluded to in
Part one.
The famous summer night.
in nineteen fifty nine in Omaha.
Charlie.
Is back in town.
Briefly.
to settle his father's estate. His father Al had passed away.
And the Davises.
Say
Oh, we're now we're investors with this local guy.
Warren.
We've told him about you.
Three years ago we met him, he seemed like you.
Let's set up a dinner and you guys can we'll introduce you.
You guys can meet. Both Thorn and Charlie, I think are
Skeptical going into this dinner.
But the legend goes that they all sit down to dinner.
And it's like
Electric.
Warren and Charlie hit it off right away, which I think is true.
And then the legend goes that at this dinner
Sarley
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. 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. And uh yes.
Apparently Charlie did actually start rolling on the floor of our restaurant.
At one of his own jokes.
Which is uh 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.
Yeah.
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 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 out so he can finish telling the story. Like this is a man that
Loves to talk.
it doesn't come out as much in Berkshire meetings until you sort of get'em going.
But yes, in social situations, he is the center.
It's so funny because if you just watch the annual meetings, you would think that Charlie is the silent partner. Nothing could be farther from the truth. So
During this dinner,
Warren and Charlie are like
Enraptured with each other.
And
As they go along, Charlie's getting more and more puzzled because
All Warren is talking about is businesses and companies and
Investing and Charlie loves this. He thinks this is great, but
It wouldn't even cross any normal person's mind that
This could be your
job at this point in time. You know, like we talked about in part one, like
maybe a couple of people in New York, you know, maybe Ben Graham could do this, but
The idea that
somebody in Omaha, even somebody in LA could do this as their full time job.
Uh only Warren was thinking this way at the time.
Hm.
So eventually Charlie asked Warren, well
What do you do exactly for a living?
And uh Buffett's like
Well, you know.
I have these various uh
vehicles, these various partnership vehicles, because at this point he hadn't consolidated them all yet. These are all he has like seven or eight different
partnerships that he invests from.
And mind you, the setup is there's no fees. He's not drawing a salary from any of these.
Yep. He's just working out of his uh spare bedroom at the house in Omaha living off of
His what was it, hundred and seventy five thousand dollars that he had
Left Graham Newman.
So Charlie though, this strikes him as brilliant and he's like he looks at Warren dead serious for once.
And he says.
Do you think
I could do something like that.
Out in California?
And supposedly Warren has chronicled.
sits there and he he thinks for a minute.'Cause you know, Warren is
Yeah, he's very polite, but like he's also, especially with people he respects, you know, very
honest and direct and you know he he doesn't think many people can do this. But he thinks and he says
You know?
Yeah.
I'm quite sure you could do this.
And Charlie.
You know, it changes his life this uh this dinner. He goes back to LA, he keeps practicing law.
He's not ready to
go all in yet on investing.
But he raises some money, he starts a partnership.
And he starts emulating
Warren investing on his own out in Los Angeles.
Susie Buffett, who is at the dinner, although a silent participant, says uh in a quote in The Snowball. She says, I think Warren felt that Charlie was the smartest person he'd ever met.
And Charlie felt that Warren was the smartest person that he'd ever met. Uh and
For the two of them, that was quite the high compliment.
So
Margaret goes back to LA.
He starts investing.
He also leaves the law firm that he was at and
Starts.
A new law partnership which
It was originally called Munger 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.
But he doesn't stay there long. He only stays at this new firm that he starts for three years.
And then in nineteen sixty five he's doing so well investing.
That with Warren's encouragement.
He actually leaves MTO.
Um
Just like one becomes full time.
Running his partnerships, investing.
An MTO, despite the fact that
Charlie was only there three years, is still MTO today, right?
Still MTO today, yep.
Amazing. And I know that like
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.
And your name first.
Right.
It's wild.
Totally wild.
So
Charlie starts.
Oh.
in his sort of investing style.
Doing the cigar butts and the like, and he's talking to Buffett all the time. They're always on the phone. He's absorbing
All the Ben Graham philosophy.
But it quickly.
That he's wired a different way.
So
He starts saying to
Warren and some of their other friends
this line that is sort of puzzling to them.
Charlie says.
You know
I really you know, I just like
Great.
Businesses.
And
That that's like not computing with with Warren and the rest of the crew. And Warren's like you mean mispriced assets or'cause that's what we're doing here. We're buying mispriced assets. And when you say great businesses, you know, what do you mean by that?
Right.
You know, as we talked about last time, Warren
Yeah when he gets a great business like a Geico or you know an Amex
He's still the 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.
Charlie though
So the story goes that what really gets him
Down this line of thinking.
Is
At one point he invests in a
Uh caterpillar tractor dealership.
in southern California.
Mm. And this becomes a
Total albatross. Because the problem was
As the dealership, you gotta buy the tractors from Caterpillar up front, 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 gotta 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.
And ideally too, that it consumes as little cash as possible. Right. 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.
He's like, I want to give you cash once.
And very little of it. And then I want you to give me
A lot more cash.
Over time with me never giving you any more.
This is best paraphrased in the line from Poor Charlie's Almanac, which was an awesome source, which is a better business.
And it postulates there are two kinds of businesses.
The first earns 12% and you can take the profits out at the end of the year.
The second earns twelve cent, but all the excess cash must get reinvested.
There's never any cash.
It reminds me of the guy who sells construction equipment.
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.
We hate that kind of business.
Totally.
So
All right, Charlie's starting to think about this and then he starts really going down the rabbit hole. He's like, Well what
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. It's a
It's a reason why competitors can't come and arbitrage her.
Differential profits away, kinda sounds like.
Hamilton Helmer and Powers, right?
So
Warren and Charlie are spending a lot of time together famously
Warren and Susie start vacationing in southern California just so that Warren and Charlie can
Talk for hours.
And when they come out.
Warren's already a millionaire at this point.
The family stays in a motel on Santa Monica Boulevard.
And then commutes over, drives over to Pasadita. Of course.
So
One they're hanging out because they respect each other's intelligence, but
But
Two, Alice points out in the snowball, there's there's actually a second reason why Warren likes Charlie so much.
And that's the
As Warren's starting to get more and more known.
In Omaha and
And on the national scene for his investing track record.
Nobody's willing to tell him he's wrong anymore. Everybody's super deferential to him.
And as Alice puts it.
Charlie's
Deference to Warren was limited.
By his high opinion of himself.
That's awesome.
And that is something that we start to see play out here in the late sixties.
Where
You know, Buffett was famously very shy about ever sharing investment ideas. 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. You know, maybe this business is interesting, but they would kind of talk around it.
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.
Yeah.
Totally.
That brings us back to
At the same time, Charlie's starting to go down this different path in
Philosophy.
And
Munger starts saying and he says to Buffett, he's like, Hey
You're like
Obsessed with this Graham guy.
And like I'll give it to you that that's a great strategy. It works. It met
Graham at several points this time. Graham also lives in Southern California by now.
But he's like, hey, he's not God and
There's a
a flaw in the cigar butt thinking
Which is that it w it it was driven by the environment that Graham
came of age in and the depression 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.
And
You know, here in the post war era.
in the US, especially in California, it's super hard to look out at the future and not see opportunity.
So Charlie starts haranguing Warren about this. He says a great quote. Because Warren is so good at explaining Ben Graham, 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. In other words,
Warren is falling victim to one of the oldest human misjudgment tendencies in the book, the man with a hammer syndrome.
And what's that like when you have a hammer or everything looks like a nail?
Exactly. So
Eventually.
Charlie does start breaking through to Warren.
right around this time as Warren is shutting down the partnership. He's so
You know, he's so uh
Depressed he's
worried about the market. He doesn't see
Opportunity ahead, he only sees hazard.
But
At heart though.
Warren is
An optimist.
Yeah, it's interesting when you're
95% aligned with your teacher, it's easy to just try and do things exclusively their way. And it's only when you start really feeling yourself and feeling your
your legs under you a little bit, 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.
All right.
So this leads us to
the first big thing that Warren and Charlie do together.
Which is blue chip.
Stamps.
And I remember I used to what I used to hear Warren and Charlie talk about
Blue chip stamps company. I thought this was like a quaint
Uh like stamp collecting store franchise, you know? I assume that too, yeah.
Exactly. Like a baseball card shop or something.
No, that is totally not what this was. So this is some like
Wild Americana history.
And when we say the first thing they do together, we should be crystal clear here.
They are not Warren and Charlie on a stage the way that you see them today. There is Charlie who is doing Charlie's partnerships and Warren who's doing Warren's partnerships.
Yeah.
So
What is blue tip stamps?
So
Around the turn of the century, the turn of the
Twentieth century.
department stores 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.
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 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. They they did want to incentivise paying with cash.
'Cause cash flow. Exactly. So this was a way to incentivise.
Paying with cash. So
Somebody had a brilliant idea.
that it would be better if you actually
Operated.
The stamp service as a separate

So that customers can get stamps.
From lots of stores.
And then like aggregate'em, get lots of stamps, and then redeem'em for you know more.
Prizes.
It sounds so convoluted when you sort of explain it this way.
Totally. But
This business turned out to have two extremely attractive
Qualities.
One.
It had float. So
the stamped companies that were running the stamp operation
The
businesses, the stores, they bought stamps
in advance from
The stamp company. So like your uh department store.
You're like I'm gonna buy
five hundred thousand dollars worth of stamps that I'm then gonna give out to my customers over time to incentivise them.
And they they buy it at a district. Wow, so you better keep those in a safe,'cause those are like cash.
Yeah, exactly. And then the they would give money, give US dollars to the stamp company in exchange for the stamps.
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. You know, it could be years from the time
the stamp company sold the roll of stamps to the store. Sounds like an insurance company.
Exactly, exactly. So there's float and then two, even better.
There's network effects in this business.
two sided network effect. Right. The more
stores that use a given
Stamp system versus a
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, et cetera. Right.
Right. So yeah, consumers want more stores to support it.
Stores want more consumers to use it.
Yeah, it makes total sense.
So by the middle of the century.
There is one dominant national player in the stamp business, the S and H green stamps.
Except
In California.
Where
A bunch of stores had banded together and shut out
S and H and launch their own stamp.
The blue chip.
Stamp company. Amazing. Unbelievable.
I had no idea about any of this. So in nineteen sixty three
S and H and the Department of Justice
Both sue Blue Chip for
Monopolistic practices. SH is trying to get into
California.
And
recruits the DOJ. Why the DOJ wasn't like, hey, S and H you're a monopoly too, but anyway. Regulatory capture, I guess.
Yeah.
So
The stock gets
Pummeled when these
Lawsuits happen.
But
Mungers heard about this in LA.
And he tells Buffett and also their friend Rick Garin, who's part of the Graham group, which becomes the Buffett Group.
Remember, Munger's like a highly, highly experienced
Top notch lawyer.
Corporate lawyer.
He says
What's gonna happen here is blue chip itself is gonna be fine.
But the government, what they'll do, what the DOJ will do.
They're gonna force
All of the
California store chains that collectively own blue chip.
To divest it.
Mm and
Who better to buy it?
Than us.
Huh.
So indeed that is what happens.
In
Nineteen sixty eight.
Blue chip agrees to a consent decree with the DOJ where the stores have to sell off forty five percent of the company and boom combination of
Munger, Guerin, and Buffett.
All snap up.
Forty five ish percent.
In
Blue tip.
And of course like
This sounds complicated to me because each of them represent a different shareholder base. They're sort of talking to each other. Feels like s something could be fishy there.
Yeah it it could be. It could be. Uh, as uh the line that we shall see in a minute is there's gotta be an indictment in there somewhere.
Okay, so now we're in
nineteen seventy.
Warren has just unwound his partnership.
And distribute it out.
Shares of
Forks.
diversified retailing, which was a J V essentially that he had with Munger's partnership to invest in department stores.
Ill fated idea. And then Blue Chip.
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.
Well he does.
And so just to s be super crisp here, Warren owns some Berkshire, but Charlie doesn't own any Berkshire at this point. This is nineteen nineteen seventy. I think none at this point.
They've created the J V of Diversified, so they're definitely in that together and they both sort of share this idea about blue chip, so they both are big holders of blue chip as well.
Yep.
So
After Warren winds down the partnership.
He
By so much
stock in these three companies from his former partners.
That
His ownership of Berkshire
doubles from eighteen percent to thirty six percent.
His ownership of diversified doubles from twenty percent to thirty nine percent.
And he buys so much blue chip that he goes from two percent to thirteen percent.
ownership in blue chip. Just personally. So Susie's like, Oh no. Second retirement is gonna look exactly like the first retirement here.
And this really was the case, right? He was like, I'm winding down my partnerships, where I'm I'm done. W was the line something about his style and sensibilities no longer being suited to the current environment, and yet here he is heavying up on these three stocks.
Yeah. So
Warren isn't the only one.
Buying.
These stocks.
Berkshire itself.
Starts.
Buying.
Blue chip.
So pretty soon.
Berkshire.
Warren owns thirteen percent of blue chip.
Berkshire.
Hold seventeen percent of blue chip.
Diversified.
owns sixteen percent of blue chip and Munger's partnership on his own owns eight percent and Garin owns five percent. So sixty percent of blue chip
is owned by these six different
Entities.
All of which
Also own stock in each other. Now listeners, if you're feeling like this is convoluted
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.
So does the SEC.
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.
The actual business of blue chip
Enters a major
Secular decline.
So
During the decade of the nineteen seventies.
Blue tip's core business, even though they settled the DOJ suit.
The core business declines ninety percent over the decade.
Because consumers are just not that interested in stamps anymore.
credit cards are becoming a thing. Just seems like an outdated kinda
Thing.
So the business is declining. Then why were the why were they so excited about buying the stock? Just'cause it was at historical lows and they felt like it was a low multiple of the profits it was generating?
I think the other part of it is the float.
So just like Berkshire.
Blue chip is
Declining.
in its core business.
But it's still got this super attractive
Float dynamic.
And if they don't own it outright, like why is that attractive?'Cause they can't use that they can't take the cash out from the float to use it for something else, right?
Right. Right. They can't take the cash.
Out of blue chip.
But they can redeploy it within Blue Chip. So
They say, Hey, let's run the Berkshire playbook that Warren you just did with Berkshire.
Let's start looking for other
operating businesses to go by with our float here.
Uh.
Blu tip.
So
They tell Blue Chip's president, a guy named Bill Ramsey, to start looking about for for companies to acquire.
And one day in nineteen seventy one, he calls Warren and Charlie and he's like, Hey
I've got a I've got a pretty interesting.
Acquisition target here.
It's a small little family company here in LA.
Called C's Candy.
And so Warren and Charlie come in, they start looking at the company and
It's actually pretty interesting. So sees people love it. It becomes wildly popular across California.
starts expanding
They develop a slogan that uh
They wanna be known for C's quality, which is supposed to be even
Better than
Top quality. You've got like high quality, top quality, and then C's quality.
It's so ubiquitous.
In California.
That you know the famous I Love Lucy episode where um already no.
Oh, you definitely know this. It's like one of the most famous moments in television.
in the fifties 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. So
The problem with Cs though is
From
Warren and Charlie's perspective is it is decidedly not a cigar bud.
So
the factory and the stores and the hard assets on the books.
Are valued at five million dollars.
But C' already has an offer on the table for thirty million dollars. So this like fails
Every Ben Graham.
Test in the book.
It's so crazy to me this like notion of cigar butts that that like you're trying to pay
less than literally just the property planet equipment, effectively. And like we're not even talking about
You know
profit multiples here. We're literally just talking about like, well, are they asking you to pay more than the than the liquid value of all their assets? And like
Oh no, six times the property plant and equipment. Ah, too far afield for me.
But this is where
Remember we were talking about Charlie starting to get this tingling about great businesses and he's influencing Warren. He's like
Hey.
Warren.
Let's actually look at the
revenue and like earnings side of the equation here.
This company is doing four million dollars in annual pre-tax profit.
And that's growing at twelve percent per year.
without putting any more capital into the business. Like this is
It might actually be worth paying this price.
So then what, that's about eight X?
Trailing twelve months profit multiple.
Totally. I mean, imagine that. That's the offer. Yeah. That's the offer, right, on the table. So Warren, of course, he hems and haws about it, and he's like
I can't do thirty.
But we could offer twenty five million. And he 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. So if we raise the prices
Maybe I can
Get comfortable. 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. Yep. He's starting to come around. So they do get the deal done with the family.
Blue chip buys Cs for twenty five million dollars.
And over the ensuing years
This little candy company delivers over
Two
Billion dollars.
in free cash flow to first blue chip and then when it would get absorbed into Berkshire Hathaway.
For a purchase price of twenty five million.
This is the first time.
Yeah.
This concept of a
A wonderful business at a fair price.
Versus a
uh fair business at a wonderful price is executed by
Warren and and with Charlie's influence.
And uh Warren
After
A brief period of time of seeing the C's operating results.
becomes a total convert. So he would say
Later uh 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. He says, Charlie understood this early.
I was a slow learner.
Love it.
Meanwhile, Charlie is also learning from Warren.
that managing other people's money maybe isn't so great.
So Charlie's partnership before
nineteen seventy one, seventy two had
Done. Not quite buffet levels of performance, but
generated.
twenty eight point three percent IRRs for the first decade, which is still
Fabulous performance.
But not as steady as Warren. That's the thing to notice about Charlie.
He did lose money some years.
He did. So he had some real big ears and some down years.
And then in seventy three and seventy four
Charlie's partnership falls.
Thirty one point nine percent and then thirty one point.
Five percent.
Oof.
And uh this is super scarring for Charlie.
He feels like
He's gotta like if he can get
Almost like Warren and his sister been the first stock he bought back in the day. He's like
If I can get the partnership level back to
Roughly what it was.
I'm gonna
Work like hell to do that, but then I'm out.
So he does that in seventy five. He returns seventy three point two percent
on the partnership in seventy five.
And then he winds it down. He's out. He says, You know what?
Warren's having a good time with this uh this Berkshire model.
I'm gonna do the same thing here at Blue Chip.
Yep. And the difference being
Yeah, Charlie was still running other people's money at that point, and I think he was doing a more traditional model, m management fees and
effectively carried interest or some kind of promote.
that he was getting above some certain hurdle.
But
You know, in that business, when you're losing money, you feel it really hard because you're being judged on that performance. Whereas with Warren
the only other stakeholders that he had to think about were the the other shareholders in those businesses, but Warren had made no promise to them of I'm going to be effective with your capital. It was, you know, the structure was look, I'm invested in this
company, this C Corp, you're invested in this company, this C Corp.
Like
Y you can get at it any time. I'm not managing your money for you. Yep. And so he just has all this. He is the weight off his shoulders. He can only lose his own money. There's no one else to be mad at him. And uh, you know, if he does well, it's just for himself, but he's got a lot of money, so he can
He has the firepower of a lot of capital without it.
being other people's capital.
Yeah.
And if the stock goes down.
Great.
He might just buy more of the stock. Like he doesn't need to feel terrible about that. He's not gonna put up a negative number at the end of the year for someone. Right. He
does want to make sure that Berkshire never goes out of business. That's incredibly important to him. But
Yeah, any given year's performance.
Doesn't really matter. That's not how he looks at things.
Anymore.
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All right.
In
Nineteen.
Seventy one.
Back when they were starting to look at C's, Warren and Charlie for Blue Chip.
Bill Ruane from the Squia Fund.
calls up Warren and says
Hey, next time you're in New York.
I wanna set you up with one of my classmates from HBS.
This guy that I really think you'll enjoy meeting.
Why don't you get dinner with him? His name is Tom Murphy. This is probably the fourth episode that Tom Murphy's come up on and acquired. Yes, we've talked a lot about
Tom Murphy or Murph, as he was known.
And uh is known. He's still alive. I think he's ninety
Five? Oh awesome.
Yeah, amazing.
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 fifty percent of Disney?
More?
Uh yeah, I think that's right.
E S P N
A B C, all the television stations.
And they do it.
All with no
further capital investment after that one T V station.
Unbelievable. One very large and notable exception that we're gonna talk about in a few minutes here.
So they get together.
And Warren is
immediately impressed with.
Murph and with capital cities and
He just loves everything about this business. And of course, he's already familiar with the media industry, he's intimately familiar with the newspaper industry.
He knows a little bit about the
If not.
Television the sort of
moving picture 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, then
What is the
Unbelievable company.
that in addition to Gygo, in addition to Amex
Buff it.
Had briefly owned.
five percent of during his partnership days.
Disney. The freaking guy owned Disney and he sold it like after what two years or something of of owning it when it reached its uh
You know, w what he felt was a good price for him to get out.
Unbelievable. So
Yeah, I think it was uh I think it was one year. So
In nineteen sixty six

eighty million dollar market cap. The Walt Disney company and an eighty million dollar market cap.
And it's not like Disney was much smaller back then. Like it was still
Freaking Walt Disney and uh
It had the theme parks and everything.
Mary Poppins had just came out.
And made thirty million dollars at the box office.
And the stock went down because Wall Street was like, Oh well
movies. That's a hits driven business, you know. The next couple of years comps are gonna be real tough after that Mary Poppins. Like Mary Poppins just made thirty million dollars in revenue and the whole company is valued at a market cap of eighty million.
Yes.
Yes. Unbelievable.
Warren though, being smart being Warren, he's like wait a minute.
It's Mary Poppins.
They're gonna be able to
generate revenues for years after this. Like kids aren't only gonna want to see Mary Poppins.
Once and in one year.
Every generation of kids is gonna wanna see this thing. Have it take it out of the Disney vault.
So he values
The company in his head.
Just off Mary Poppins. He's like the theme parks, all the other movies, let's assume all that's zero. That's my margin of safety. He thinks that it's still worth more than eighty million dollars just on Mary Poppins.
He puts
four million dollars of partnership capital into Disney buys five percent of the company.
And then of course Warren being
Warren at the time.
Within a year he's made
two million bucks on that. He's made a fifty percent return and he sells the whole thing.
My God.
What's the quote quote better to be approximately right than precisely wrong?
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.
I mean it okay, so the principle of that quote is
Look, there's no way that you're gonna be able to exactly know the intrinsic value of the company. So you sh you will never know exactly what you should pay for it, either on your entry price or your exit price. So
You know, it's the margin of safety idea that
you should be approximately right. 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.
Well like
You were way, way off on what the intrinsic value of this enterprise could be. 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. In a in a way it's commission because he actually
had to act to sell the stock, but
Gosh, how how different his net worth would be and and who knows about Berkshire's future, but if he had continued to hold five percent of Disney at that point.
Totally. I mean
Gico, Amex, Disney. We're not even talking about Intel. These are all companies that Buffett owned like a meaningful percentage of in his very early days.
And uh
Didn't hang on to him.
No. All right. So he knows about the moving picture business from a little bit of Disney. So he's sitting down He's sitting down with Murph. He and Murph are are hashing it out and Murph says to him what?
Murph says.
After the dinner.
Murph is so impressed with Warren's
Yeah, sort of like management, investing mind. Like these are
Two people cut from the same cloth.
He decides that he wants
Warren to join his board.
So he flies out to Omaha, he makes a pilgrimage.
to go see Warren and he says, Hey, I really want you to join
The capital city's part.
He would have been really impressed with Warren's head office.
Yeah, exactly. Like if you think about how Capital Cities was like incredibly lean, uh this is like the only person who would walk into Warren Buffett's office, look around and be like
Awesome.
Love it. I think there's some famous story
Didn't we tell in the SPN episode about how they only painted the front of their buildings?
And not the sides and the back. That sounds right, though.
Uh amazing.
So Warren's like
Look, Tom.
I love you and Dan, but
Honestly the the only way that I can join your board is if I were to own a
A large chunk of your
Company.
Uh and this is like a an an impasse because
Just like Warren.
Tom equally feels like issuing stock is
The ultimate sin.
And he refuses to do it.
So they agree that they're just gonna be friends.
They will
turn to each other for advice on their various businesses for the time being. But
There's not gonna be any any formal relationship.
It was also quite
convenient of Warren.
To do this.
Because he knew
That
the FCC rules were such that
The
Would not let anybody
Yeah.
Uh
Multiple
different companies that owned television stations around the country.
And Warren's got his eye on another company.
That owns some television stations.
The Washington Post Company.
Ah right. I didn't realize I forgot they they had gotten into T V at this point already.
Yep.
They had, they had.
So
His boyhood dream, his paper route.
And the reason he's got his eye on the post
Is they've just
done a public offering.
What what year is this?
This is nineteen seventy one.
Seventy one. Okay. So still only like a year or two after he's wound down the partnership. He's still in retirement mode.
Here's a little early carve out too for anyone who who wants an unbelievably good sort of dramatic telling of that IPO and the events around it, go go watch the post.
With uh with Meryl Street. Oh, it's so good.
We definitely have to do a whole episode.
On the Washington Post company at some point.
But suffice to say for now that the story is
equally, if not more, amazing than the New York Times company.
The short version of it is
That heading into the IPO
The post has been in the Meyer slash
Graham family.
for forty some odd years at this point.
The CEO
of the post, but not the chairman.
The CEO is a woman named Catherine Graham, who her story is just
Probably many folks have heard of her. It's just
Amazing. Watch the post and and we will tell it someday. But
She
assumes the role of publisher and CEO at age forty six 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.
She was one of the CEOs that Will Thornteck profiles in uh in the Ops Buck.
So great.
So Warren
Sees all this from the outside. He's got the attachment to the post. The IPO is happening and he says
This is gonna be my
My opportunity to come back.
So he reach out to her initially.
With
An idea.
Tread carefully.
Km and the Graham family and what
They've built.
Yeah.
Also
knows that it's a dual class share structure. So
They have control. 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.
So he reaches out with an idea and says
I've heard that the New Yorker, the magazine, is for sale.
Would you be interested in maybe doing a
Fifty fifty.
Big.
J V to buy it together.
And she has no interest in that, right? Like she has no interest she's like
I'm learning how to be a CEO here. We're taking the company public.
The Pentagon papers are happening. Uh no. Very nice to meet you, Mr. Buffett from Omaha, but
Thanks, but no thanks.
But
Warren's like it's like I've I've gotten to know her. I've I've
Got my foot in the door.
Two years later.
the person who was chairman of the Washington Post company, Fritz B.
Who I believe was a long time.
Family lawyer.
uh of the Myers and the Graham.
He dies and his estate is being liquided, of which there's a lot of
Post stock in it.
And Warren arranges to buy a fifty thousand share block.
From
Yeah.
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? What this guy at Omaha?
And he'd also been buying on the open market, too.
And he now owns five percent of the company. So when he's having dinner with Murph, he's like
He's already got his his plans in motion here.
So
Hm.
Writes Kay a letter.
Remember, they've already met.
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.
Writing a check separates conviction from conversation.
I recognize that the post is gram controlled and gram managed.
And that suits me fine.
Huh.
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. Exactly. He wants to be
Mm.
Partner.
Two great managers.
And storage of
Generational businesses.
K, nevertheless, probably rightly is uh
A little spoot.
I bet.
You get an activist and investor who suddenly sends you a letter and says, By the way, I own five percent of your company.
Yep, that uh and you're just so great. It uh it suits me fine that you control it.
It probably also is known at this point the way that he sort of uh rated the textile mill company of Berkshire Hathaway.
U if you go digging on Warren you can find
Some skeletons in the closet.
Yep.
So she agrees to meet with him briefly when she's out in Los Angeles.
Yeah.
Thrilled.
She shows up at the meeting famously looking like
Okay.
She's
Kate Graham she's like one of the most prominent Stately Stately one of the most prominent
People in the Washington social scene. She's probably the most powerful woman in America at this point in time. Hanging out with presidents. Yeah. First name basis with
Yes, everybody in Washington.
And Warren shows up looking like, you know, the bedraggled uh wrong size suit uh, you know, guy from Omaha.
From the hills.
And she thinks this is just hilarious. They hit it off right away in this second meeting.
And she says, You know what?
Maybe this Warren guy isn't so bad. Why don't you come back out, meet with me again in
Washington.
So
He comes back out to Washington.
uh shows up right in the middle of the Watergate proceedings where Kay and our publisher Ben Bradley have pulled an all nighter the night before
Making decisions about
What to publish about Watergate.
But she still makes time for him.
They go
Out to lunch.
And then afterward, Buffett presents her with a contract.
That he's had.
Drawn up.
That legally binds him and Berkshire.
That they will never buy another share of the post without
The Graham families.
Permission.
By the way, by that time, Warren already owns twelve percent of the company because he's kept buying.
In in exchange for what? Like why why would he say
Just we voluntarily not an exchange for any he just he he just really wants to be on K's good side and he he really, really wants to be on the Washington Post board.
And so he's kind of presenting I think he
uses the term the he he invokes
Little Red Riding Hood and uh
The wolf, he says, you know, I may look like the big bad wolf, but we're gonna take the fangs right out of the wolf.
I'm never gonna buy another share without your agreement. I've had this contract drawn up.
It's kinda funny, but Kay loves it.
And uh
They steal the deal, she says, Well, okay then, you know, I'll start calling you for advice.
And what Warren really wanted her to say was
Why don't you join the board then as a twelve percent owner of the company, but she doesn't.
Warren.
Desperately wants to get on the board.
And and why does he want to get on the is it an emotional thing or is it I mean, we haven't talked about
Why?
Warren views
a paper like this as such an incredible business. Is it is it worth taking a moment on that?
I think the board thing specifically.
is probably an emotional thing.
But
The paper.
Yeah, at this point.
It's
Not only the dominant
Paper 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.
So it both has that franchise effect in Washington. 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 I don't think we'll get to today.
But
Buffett famously referred to uh 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. So, you know, it's a it's a license to print money. So there's definitely his notion of
a franchise town newspaper is awesome. This is one of the ones in the most important town in America. And now it has this national international reach. Um 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 and of course there's delivery costs, but freaking good business that's wonderfully defensible.
Yeah, and I think
Specifically.
On
that defensibility of the newspaper part of the business at the time.
and the the the winner take all network effect in 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.
And once you get the ad dollars flowing in from the advertisers
Then you can offer
Deals. It's like it's like the group buying clones in in in China. You can offer subscription deals to enough subscribers to
Grow your subscriber base.
That you can crowd out all the competition.
And
That market.
Just naturally.
Tips to
A single player.
And that's
happening in Washington and uh
Large city.
Fantastic newspaper franchise. All right. So he's built himself a twelve percent position. He really likes the company. He wants to get on the board, but he's not on the board.
He's not on the board.
What happens next is like a middle school dance. It's hilarious. So
He doesn't have the
courage to say the K
Yeah.
Well, hey, I I'd really like to join the board and I presented you with this.
Contract.
Instead.
He calls up Murph.
And he says
You know, gosh, Marf, I I really wanna
Wanna join the
the board of the Washington Post, but
K doesn't seem to be getting the message.
Do you think you could
Go see her and
Tell her what uh how great a guy I am and
You know, that that I'm really not so bad in and
I really do want to join the board if she would just ask me.
Wow. So Murphy Tom goes to C Kay and tells her
And she's like, Oh my, well
Yeah, um
I I guess it would be nice to have him on the board. I really respect him.
Well
But I can't really just send him a letter and ask him. Like he he should really ask me.
So Warren is like
I'm gonna invite Kay out.
to by this point in time.
He and Susie have a house in Emerald Bay in Laguna Beach in in Orange County in California. I'm gonna invite Kay out to a weekend.
at the the family house and
In California.
And I'm gonna be like it's gonna be perfect. I'm gonna host K
The socially
Make it perfect for her and you know, at the end of the weekend then I'm gonna make the ask to join the board.
So he's really putting on a show for K.
She comes out, she's a little puzzled.
The whole weekend goes by, he doesn't ask, he doesn't ask.
And then on
Sunday morning.
Kay finally turns to Warren and says
So I hear you want
To join the board.
But I'm not sure, you know, I'm I'm waiting for the right time to do it, to bring it to my other board members.
And supposedly Warren, you know, looks at her with
Longing eyes and says.
Okay, when is the right time then?
And they're
Fall into each other's arms and she says, Oh, join my board and
This is the beginning of
And
immense friendship between them.
They become incredibly close for the rest of Kay's life.
They
Go to events together.
They spend weeks at a time together.
In each other's houses, in each other's apartments in various cities.
It's never been written whether this relationship was
Purely platonic or
Also romantic.
Unsure, but
It certainly becomes a
Yeah. Amazing relationship.
Would stay.
on the board of the post for
Most of the next thirty seven years. Oh, I didn't realize it was that long.
Yep.
So the
Twelve percent.
Steak.
Yeah.
Buffett Buck for Berkshire.
Cost.
Ten million dollars.
And in twenty fourteen.
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
Pisa spies.
Yeah.
Berkshire sells at stake for one point one billion dollars.
Which is only a twelve percent IRR from the initial ten million dollar investment.
However.
The post had also been paying dividends all throughout those Oh wow.
Forty, fifty years. So
I don't have the data on total dividend return broks are received in cash flow at dividends.
From the post, but
Suffice to say it was
An excellent investment on Warren's part.
So ten million for one point two billion.
One point one.
One point one. Wow.
By that point it's funny, it's actually not a big holding for Berkshire, uh, relative to to everything else they own by the time they they uh
Bezos buys the post.
Yeah.
And
You know, Bezos ends up buying the post, I think, for two hundred and fifty million. Something like that. When that happens in twenty fourteen, twenty thirteen, twenty fourteen.
Certainly the value of the post during the heyday of the newspapers of the nineties and two thousands was
Much, much, much higher than that. And the cash flow that it was spitting off that than sending back to Berkshire.
Another shareholders was significant.
Did you hear, by the way, a little Easter egg that in the in the annual meeting one of the the questions that Becky Quick from CNBC was uh written in by Don Graham.
No, I didn't see that.
Yeah.
Amazing. Don, of course, being K son who
would take over, uh I think he became CEO before her death and then and then after her death became chairman and CEO.
Too funny.
Alright, so that's the post.
So let's
reset a little bit on time frame and sort of Warren's evolution here.
Everything's not yet consolidated under Berkshire, right? Like who was accumulating the shares of the post?
So that was
Burkshire.
Okay, but he's got this whole blue chip stamp thing going on. Yep, and diversified.
And so we've been alluding to
The hot water that they get into with the feds.
So
Right as Charlie's
Closing down his partnership. And this is like seventy five ish. Seventy five. Yep. In seventy five.
He and Warren get a call
from one of Charlie's former partners at MTO.
Chuck Rickerhauser.
who had done the C's deal for them.
And Chuck says.
Hey guys, I just got off the phone with the SEC.
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.
And he famously tells them.
Chuck would spend.
like weeks putting together a corporate flow chart of all these different entities and who owns what. We'll we'll try and link to an image of it in the show notes. It's amazing. There's so many different
Subsidiaries and sub entities.
And he
Looks at it and he says.
There's gotta be an indictment in here somewhere, guys.
I don't know what you've been doing, but
I remember reading this when when I was doing the research and
Yeah the buffet image that you know of today, the sort of folksy
near benevolent um multi billionaire or multi deca billionaire. I don't even know the right phrase for it. Would be hundred billionaire if it wasn't donating so much to the Bill and Melinda Gates Foundation.
That he
was in hot water with the SEC. Like it's just the last thing that I would have expected, uh, as sort of the
Buffett novice before I started doing the research. It's still when I was reading about this, I was picturing Warren and Charlie like Tupac and uh
Picture me rolling and the the Federalis want to see him dead.
That is an image I can never unsee.
You can never unsee that.
But it's so apt. 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
spin on the tail because Warren especially is, you know, now becoming so known. 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 West Co Financial.
That
Blue chip had bought
After C's they'd kept looking for
Other great businesses.
And that they'd bought a stake in Westgo.
And this some kind of bank, it's like a financial services business at this point? Yeah, it was it was a financial services business in Southern California. And
What happened was
There was another company.
I think
Santa Barbara Financial Corporation or something like that. Financial
Corporation of Santa Barbara.
That had a buyout offer for West Co.
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 West Co instead. So there was still a stub kind of basically backstop the price. Cause they're like, look, we already we hold a bunch of this already. We're not gonna let you buy it for this really cheap per share price. So we're gonna come in, we're gonna 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 gonna get away with this steel that you're you're coming in.
And so
W the way it goes down.
Is
They
through their work in convincing, you know, the board and the family that owned most of West Co
They convince

When
The merger drops the s the West Coast stock.
False, of course. And that's when
Warren and Charlie invest, but they feel bad about
Tanking the stock price. So they decide
they they work out a deal with the company and with the family
that they'll buy shares and invest. I can't remember if it was at the merger price or maybe even slightly.
Above it.
And the feds are like, Wait a minute, there's gotta be something shady going on here.
Because like
A, you scuttle the merger. B, you then
Could have just bought the stock for
Lower, but you paid this artificially high price.
What's going on?
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.
So they're very confused. So
Warren ends up getting subpoenaed.
Um
testifies that they paid the price they did because, quote, it was important how West Co management feels about it.
Now you can say, Well, we own the controlling interest, so it doesn't make any difference.
But Lou Vincenti, who is the president of Wesco.
He doesn't really need to work for us. If he felt that we were, you know, slobs or something, it just wouldn't work. And Munker, when he's testifying
He of course invokes who else but Ben Franklin.
In his testimony, he says, We didn't feel our obligation to the shareholders was inconsistent with leaning over backward to be fair.
We have that Ben Franklin idea that the honest policy is the best policy and
It had sort of a shoddy mental image to us to try to reduce the price.
Well there there it's almost like the v notion of like the V C 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 gonna maximize value for everyone, including ourselves, w 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 at their expense. Yep. And he's totally right. 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. Uh many of them are
public companies, but
have a large family controlling ownership like Westco, like the like the post.
They buy these companies and then
the family or the current management often stays on and keeps working there. And I'm like, why would
Why would they do that?
And this is the key. Why? Because they're not just trying to like
They're playing the long game.
You know, they what they really want is great managers who've built great companies to stay running them.
And the way to do that isn't to, you know, negotiate every last dollar out of them.
Or even if it is, like I I think some of I think we're conflating two things here a little bit. I think
Berkshire does make sure they get a great deal when they buy a family owned business outright. You know, they they
They're good at buying low.
But
they either just believe that the business has so much future upside in it that they're they're willing to, you know, uh meet in the middle on price.
Yeah.
They
are very good at identifying managers who have a splinter in their mind to continue to do the work.
Like there's something about th they're very good at this.
Shrewd evaluating
Even if this person no longer holds a a a single share of their company, are they gonna show up for work every day because this is their life's mission and purpose?
And uh
You know, I'm not totally I don't think that's what was going on in the the West Co financial situation, but I think when they buy these family owned businesses, there's a lot of that in the evaluation of the business.
And they
They definitely compensate.
Those managers.
Well.
Yeah. 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 gonna pay for the company.
Th this whole thing sucks though. Like there are 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.
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.
So
They end up
sort of coming to this gentleman's agreement with the feds.
Where
Blue chip.
Which had which had been the primary player in the West Coast saga.
Although I think Berkshire and maybe Diversified were also buying shares too, of course. Which was part of the problem.
Promises.
Not to do it again, something like this. Uh It's like no admission of guilt, but we also won't do it again. We won't admit that we did it, but if we did do it, we won't do it again.
And
Most importantly, Warren and Charlie agree to start taking steps to quote simplify
This complicated
Rat's nest structure of the
Companies that they have.
So
Right off the bat, the
finally merge Diversified into Berkshire, which they had wanted to anyway, and by this point Diversified owns a large chunk of Berkshire shares.
Charlie gets installed as the chairman of Wesco to be sort of
More arm's length than Warren.
And they make it out.
gold to merge blue chip into Berkshire.
As soon as
All of the remaining kind of legal suits wind up and and settle here.
That actually takes a while, but it finally does happen in nineteen eighty three.
Wow, that really took a while then. It really does take a while, yeah. I'm not sure exactly why.
But especially since
The SECU wants them to merge it all into one company. Yeah. And Warren and Charlie want to as well.
For whatever reason. It takes until nineteen eighty three.
All right. So
They're making an effort to cleans up. They've got this SEC thing behind them. It's the late seventies.
There's another chapter on the horizon for Berkshire.
Oh yes, is there ever and indeed?
Is a chapter.
Involving an old flame. The original crush of Warren's. This is like I think this is the thing about Warren.
You know, I don't know about his
Romantic.
life and situation. It's it's certainly also complicated.
There's a lot about that in the snowball and and elsewhere.
Not the scope of our show to get into.
But he certainly has like a
Serial love affairs with companies.
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 happen 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. It's almost like um big fish in a way. Like this man's life is just surrounded with these.
Like six sigma events.
of like these really crazy
Or Forest Gomp, 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. It's just crazy, work for his grandpa.
Yeah.
Well it's also funny that like
Warren and Char more Warren here than I think Charlie.
He's so smart and so analytical. Like
You know, Charlie Munger thinks he's the smartest per Warren is 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, the 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.
Mm-hmm.
So
Of course.
We're talking here about Gago.
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in the intervening at this point it's like twenty years or so, two decades.
Since
Buffett had tragically sold his Geico steak.
The company grew.
Immensely.
It made the
acquired like
Growth in its
Target market when we went from just acquisitions to just t to telling the story of all great companies.
Beyond just targeting government employees to opening up to anybody, uh, non government employees can also get their auto insurance through Geiko.
Mm-hmm.
And this is huge.
The problem, though, was that in chasing this growth in this new
Market.
The

underwriting and pricing of risk of all of these new customers.
Didn't quite keep

Pan
If you 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, happen to be much, you know, safer drivers than the average population. It's a known data set. It's a pretty homogeneous group and you know
It's a lower risk homogenous group.
Totally.
So
They didn't really
Update there.
Enough as they've broadened out to
The rest of the population.
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.
And

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 up front, you get to use the money before you need to pay out claims.
When you misprice your risk, that whipsaws on you. Once you realize that you're gonna 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. 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 gonna have to pay out than you have.
Yeah.
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 the house.
Totally.
And
You're not able to change your odds or the structure of your game for a very long time. Or you can only change it for like new customers who come in. Yeah, the the analogy breaks down somewhere in here, but yeah. It's bad. Suffice to say. It's bad and it's not getting better anytime soon.
So
In nineteen seventy six.
The company announces a hundred and ninety million dollar underwriting loss.
the largest in its history. Maybe even the largest in like
Auto insurance history period at that point in time.
They eliminate the dividend for the company.
Because they need to conserve all the cash that they can to deal with this.
And Wall Street figures out they don't have enough capital to cover future losses. So this is like a
Crisis situation.
Insurance regulators descend on the company.
The stock
drops from sixty one dollars a share to
Two dollars a share.
Like can you imagine that? You know, what's that like?
Ninety percent.
Value destruction. You want to get to the exits before anybody else does if you're a shareholder.
Totally.
So
Warren fortunately hasn't had all of the
Cigar butt. Ben Graham, uh ironically, Ben Graham with Geico uh philosophy beaten out of him.
This piques his interest again in Geico.
So he thinks he's found another, you know, MX type situation where Yeah, like what where is Buffett to say that they're gonna recover from this? Then he's not gonna, you know, catch the knife on the way down.
Right. So
He wants to find out.
Can this actually be turned around? But unlike
The salad oil thing.
Where it was pretty easy to figure out. Like
Yeah, this is gonna be good. Like
That's not gonna be the case here. There is no way to avoid the
years of pain ahead that GECO is gonna go through.
But
There is
Something.
That Warren
see's happening that the rest of the market doesn't quite understand yet.
Which is that
Go.
You know, it a good move, fires all of its management team.
And
Brings in a new CEO.
Yeah.
Grizzled, literally grizzled veteran.
Of the insurance industry.
who Warren had heard about.
Named Jack Byrne. And this guy is a legend. And and does Warren have anything to do with installing him or ha No, no, no. This is just watching from afar. He's waiting to see if there's something that like
A glimmer of hope that maybe Geico could make it out of this.
'Cause the stock is like
Super attractive I mean, two bucks a shame.
So this is their current board, like figuring out
What to do here.
Yep.
Yep. Partially at the uh
Shall we say request of the regulators.
So like yeah, you you guys are really getting yourself uh
Up a creek here.
So Jack.
had been one of the top exec travelers insurance.
Before
He resigned in like a huff.
When he was passed over for CEO. Wow, that's gonna come full circle.
Totally.
It's absolutely gonna come full circle.
Listeners, remember remember traveler's insurance, just so David and I aren't like making inside jokes here, like as we get to the end of the episode. So Jack is like he's the man for the job.
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 gonna be terrible for you because like if we go bankrupt
All of these underwater policies
The
Regulators are gonna make you guys absorb them.
Like
Y y you don't want that. Oh man. Was that true? Was that what would happen?
Well, I mean you can't operate a motor vehicle in America without
Car insurance like so if your insurer goes under
You need insurance, and especially if you've got claims underway, like what's gonna happen to those, like if the insurance company behind those claims goes away.
Interesting. So this is the argument.
The burn makes to the industry.
Um
It mostly works. 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.
And remind us what reinsurance is.
Well, so reinsurance is any time
Uninsure
is selling off some of their risk in their portfolio to another
insurance organization.
And there are large reinsurers like Kettle, uh, that we've talked about in the show, one of my angel investments.
All they do is they
Bye.
risk off of other primary insurers books.
But primary insurers can also buy risk off of each other's books.
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
Seventy thirty.
on you know are the Patriots gonna win or the Buccaneers gonna win? I can't remember if they ever play in the Super Bowl, but 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 gonna 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.
Exactly, exactly.
In your example, I mean Tom Brady's gonna win either way. So like
That's the bet to make, but
Whichever team currently has Tom Brady is the answer to that game. There's probably a way to make that bet somewhere.
I love it. We digress though. We digress.
So
This plan actually
Buffett is like, that's a good plan.
That's like a creative plan. That th that could work.
So
He gets
Okay.
Uh remember Gico's in Washington and Kay knows everybody in Washington. Oh, he Buffett doesn't actually know.
Jack.
He gets K to broker an introduction for them.
They meet
at K's house in Washington.
Buffett grills.
Burn for
Hours and he's like, Oh yeah.
This guy's gonna do it. So just like
The first time.
That Buffett met Geico when he goes
Takes the train down, he meets
Lorimer Davidson and the very next day.
He liquidates seventy five percent of his portfolio to to load up on Geiko. The next day
After the dinner.
With Byrne 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 a company is that?
I didn't actually disentangle that versus what he would.
By
And what's gonna happen next
So it's some meaningful percentage, but after what happens next, Buffett's gonna end up with a third of the company.
Right. So this is like high single digit, low double digit that he just bought of the company.
Yeah, probably in the double digits.
So now
That goes back by Buffett.
Byr is the man for the job.
Things are looking up.
But they still need
Capital to
Operate like they're
They're out of money, they're gonna sell off some of the risk, but they've got claims that are happening now that they need to pay off.
So
They need to go raise money.
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.
Not there.
None of the big established banks want to touch.
This situation.
Except
For one. 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 the you know, white shoe banks are like, uh we we don't do broken offerings here.
So I don't actually remember who this was. I'm gonna guess by
the relationship that gets forged for future events that it's Solomon Brothers.
It is Solomon Brothers.
The Bank of Liars poker Michael Lewis fame, which we will definitely come back to in a sec.
They're the only bank that is willing to
Under a
What ultimately ends up being a seventy six million dollar
Convertible.
Dad.
deal convertible into equity.
That
They underwrite
Buffett flies to New York.
And tells us not just Solomon Brothers, it's one specific person at Solomon Brothers.
Guy named John Goodfriend.
who is a rising star there.
Remember that name, folks.
So
Good friend and Solomon.
Underrate the seventy six million dollar deal. Buffett flies
up to New York to sit down with good friend and tell him
Hey, look, I know this is gonna be a tough deal to get through even Solomon Brothers famous sales distribution channels, even your famous prescriptionists out there.
If things go sideways, Berkshire.
We're willing to underrat the deal and do all of it.
But we're gonna do it at a much lower price than what you go out with if the deal is broken.
Secret friends like.
All right, great. At least twelve.
I'll go trade on your name then at least and say tell all the all my clients like
Hey.
Warren Buffett already owns a large percentage of this company and he's willing to Okay, so what do you mean trade on his name? Like what do you mean Buffett will do it all but at a lower price? Like he would
buy the whole offering, 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? Yeah, this is the convertible I think it's convertible debt, not convertible preferred. Okay.
But yeah, essentially what what Buffett says is he's like, look.
I'm good for the seventy six million.
But
I want you to go out there.
And try and get this deal done.
At like less dilution, essentially like a higher price on the convert.
It's like when an insider
uh in a venture round tells the company, hey, like
I'm good for my Pro Rata.
Yeah, in whatever round you raise, go raise the round, go get a price.
If you were to lead it inside around, you know
I'd lead it like if you wanted to do it inside round, but it won't be at the price where you could go raise your external level. Exactly. That's exactly what's going on here.
So
Good friends, like, all right, I can work with that.
And go out.
Solomon Brothers sales and trading famous aggressive sales and trading desk. They get the deal done, it ends up being oversubscribed.
And Buffett.
does end up even though it's oversubscribed and goes out at the price that they wanted.
Warren's like all right, I think this company's gonna make it. Uh he ends up buying twenty five percent of the deal, even at full price.
Mm. For Berkshire.
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. This thing could make it out alive, and if it does, damn good business.
Yeah, exactly.
So
Gaiko is now.
Yeah.
Two of the three problem solved.
It's got it's capitalized. It's got enough money to make it through.
it's laid off a lot of the tail of of risk in their current book over the coming years with the reinsurance deals that they do.
But
It's still not pricing right.
So
The thing about
Auto insurance and most consumer insurance.
Is
You need licenses to operate in any state.
And part of the licensing process is you have like a license to
So
insurance at a certain price. You can't just like
Arbitrarily change your
price on your customers. That's the the regulators don't allow that. So it's it's a s super weird market. It's not like uh
You know.
We could change the price of the L P show tomorrow if we want.
Profitability of insurance businesses.
Exactly. So this is Burns.
Time to shine. This is amazing. This is my favorite moment, I think, of this whole second episode.
So
He goes out to
all the states individually. And he explains the situation to be like, Hey, we were mispricing
We gotta raise prices on consumers.
And some of the states are okay with it, apparently New York right off the bat is like, Yeah, we get it. Okay, fine.
But some of the states are playing.
Hardball and in particular New Jersey.
Is playing hardball.
Huh.
Uh I mean New Jersey, right? Like uh Burn and the North.
Yeah, Byrne himself is from New Jersey, so he's like all right.
You wanna
You wanna do some mafia tactics here, I'll do some mafia tactics.
So
I'm I'm just gonna read what happens next from the snowball because I
I can't do this any better than than Alice.
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 Sheeran, the commissioner
that Geico must have a rate increase.
This is now a quote from Brand.
He had a sour ass little wise actuary at his side who'd been fired by some insurance company and had a bone to pick.
Sheeran said my numbers didn't justify a rate increase. I did all the arm waving and stuff that I could, and Mr Sheeran was intractable.
Sir Byrne pulled the license out of his pocket.
threw it on Sheeran's desk, saying, I have no choice but to turn in the license
Or something to that effect with more four letter words.
He then drove off to the office with his tires screeching and
sent out telegrams to thirty thousand policy holders in New Jersey.
Canceling their insurance that day.
and fired two thousand New Jersey employees in a single afternoon.
Before
Sheeran could go to court and get an injunction to stop him.
Baird says it showed everybody, all audiences.
I was serious about this. And then I was gonna fight for the life of this company no matter what, including walking out of a state.
Which wasn't done back then.
Burns impalement.

had exactly that effect.
Everybody knew he was serious.
And so do they end up actually just vacating New Jersey and just didn't serve policies there?
They literally vacate New Jersey.
They vacate a bunch of other states.
And Brand is like if I think he's like, look, this is war. Like we're either gonna
We got a reprice.
So either we're gonna
burn the house down.
You know and and vacate these states.
Or we're gonna be allowed to reprice.
So
Gico by the end of this.
has shrunken down to
Only seven six. The original Travis Kalanick. I know, I know. It's amazing.
He uh has shrunken down to only seven states.
Vern has completely
swapped out everybody in the company famously.
It is a a lot of the sort of middle and lower management in the in the company was from the you know, the old days, undisciplined days.
Apparently at one point the then existing HR director is giving a speech in front of the company and Byrne gets so upset.
That he storms on stage.
And fires him on the spot. Literally like gives him the hook, takes him on stage, points at somebody in the audience and says you're the new HR director. Brings him up on stage.
Amazing.
Is Lorimer still there at this point in history? Lorimer's 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.
Wow.
Amazing. So
They shrink Geico down to only the seven states and
DC
That let them change the rates.
And they rate the ship. Um
They priced the
Policies appropriately.
The company gets profitable, it stops losing money.
It starts.
Growing again and then would go on to become
What did Warren say in the annual meeting, uh
This weekend I think that they have like what?
insurance company. Yeah, progressive is slightly larger, but I think they each have about twenty five percent of
The US market.
Something like that.
Incredible.
And he spent forty seven million dollars.
from nineteen seventy six to nineteen eighty to buy is it about half the company? So
Yes.
By the time the debt offering closes,
And then
When the share price jumps, I assume.
The deck converts at that point.
Berkshire owns thirty three percent of Gyco.
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.
Geico starts buying back its own stock.
So by
the mid nineties, we're fast forwarding to uh we'll we'll get to this.
Later in the next episode.
By the mid nineties.
Berkshire has fifty percent of the company without putting in another dollar
And then in nineteen ninety five
Berkshire buys the rest of Gico that it doesn't own.
For two point three.
billion dollars.
Forty seven million.
And half the company for two point three billion.
Either way they get a hell of a deal.
Because estimates are that Geiko's worth
Probably about fifty billion dollars today, maybe more. Wow.
So
That's twenty five billion of value, assuming that's fifty.
On forty five million.
And twenty five billion of value on
Two point three billion.
Either way, pretty good.
Either way pretty good. Warren's like look at me now, Feds
Listeners, uh even though this is gonna be in the
Final.
part of the trilogy. We do have to tell you that the uh in nineteen ninety six
the two point three 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 like this business forever?
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 Geiko was that
Warren.
had a big investment in capital cities.
And Disney came in and bought
A B C capital cities, which then of course, in that outright sale.
uh all the proceeds went to good old Berkshire and that was a little bit
more capital than two point three billion, but about the same amount that suddenly they had to play with to go put to work somewhere else and
Geco was where they decided to go put it to work.
Jewel to
Put that capital into
Think I go.
Amazing.
So you know it's funny, we said on or I said on the first episode
Something that I was totally convinced was right at the time, and now maybe not, where I said that
Got if if Warren had just held on to Gico and not sold.
Imagine what his returns could have been.
You know, who knows what would have happened otherwise, but
You know, Gaico almost died, right? Like if he had held on, would he've had this ride anyway and ended up here. He got to buy back in at two bucks a share.
Totally.
Yeah, that's a good point. He did get it at an extremely low basis, even though he skipped a few decades of compounding and growing in there.
It is also worth pointing out that
Despite the fact that it is a buffet mantra to hold businesses forever, hold hold great businesses that you believe in forever.
He can dump a stock just as fast as the next guy. I mean the way that he dumped all the airline stocks
Had
Probably the low point of the Covid stock crash.
It was really interesting hearing him on stage last week where he's he was totally unapologetic for that. Thought it was totally the right move.
And you could imagine that
He easily could have been convinced that that was the right thing to do in the Geico situation too.
Totally.
And
All that matters is uh
The long run.
Charlie Munger would say, Who is it?
I think it's Charlie quoting.
Tom Maynard Keynes that in the long run we're all dead. So
Yeah.
Mm.
But in the long run.
Gico becomes
Yeah, one of the
major jewels, if if not the the most important
Piece of bricks.
Especially given all the float that they
Generate. I guess that is that is the big thing that Berkshire and Warren miss over
that twenty year period where he's not invested in Geico is using the float.
Yep.
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.
The first one is identifying things that have far less risk than the market perceives them to have.
Mm-hmm. And that's things like American Express. That's things like
him realizing that brand are more powerful than value investors give give them credit for, or the magical thing of a monopoly franchise newspaper. But then there's the second category of identifying things
that should you act
will have far less risk than the market perceives them to have.
And even more importantly.
If you uniquely have the capability
To act.
then you actually can be value creative.
Like the thing that he did with Geiko 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. 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 f self fulfilling prophecy way.
the investment was way less risky.
Merely because he was involved.
Yep.
Oh boy.
Is that everyone?
Well y you really are you toss that ball in the air and I just
I
Cannot wait to slam it.
But
Before we get to Varren getting
Punch drunk on his own reputation and ability to uh to save businesses.
So all the the Geiko situation uh wraps up kinda around nineteen eighty and you know, it's off to the races.
The rest of the beginning of the eighties is just more goodness for
Warren and Charlie and Berkshire. So
Finally.
When Paul Vulker becomes chairman of the Fed.
First at the end of the Carter administration and then under the Reagan administration.
Hmm.
In a
you know, correct fiscal and monetary policy to reverse the terrible inflation that had been happening and
The eighties just become
You know.
We're about children of the eighties, like
An immense period of
Prosperity, the eighties and nineties.
For America.
So the eighties of the go go years, you know, this is
Wall Street movie. This is
Excess. This is
Everything.
And it's a good time for
Berkshire in in Omaha too, so
We won't go into all the details, but they buy the Nebraska furniture mart from Mrs. B. Incredible story. She
Think it's upset with
The way her children who are like in their eighties at this point or night seventies are running the business. She leaves, starts a competitor across the street at age ninety five when Burksner has to buy it back for five million bucks and sign a non compete with her at age ninety five. Amazing.
There's the Buffalo evening news in here, sort of in the early eighties, which is when Buffett really is that the early eighties? Yep, early eighties, yep. He gets into a good old fashioned newspaper war.
Uh, he's trying to be the franchise newspaper in the city, ends up sinking tons of capital in, gets into
W not a fight, but a few disagreements and has some words with with Charlie about the right things to do.
But you know, Buffett's a committed guy.
There's a bunch of stuff that happens in here that
We could do ten episodes and wouldn't have time for it all.
Totally.
He uh he goes to war with the efficient market.
Hypothesis theorists which is amazing.
At Columbia's fiftieth anniversary event of
The secur the publishing of security analysis, he gives this talk where he just like
He calls it the super investors of Graham and Doddsville.
It gives us 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 s simply volatility
And around the efficient price.
And that volatility equals risk. And so that is
Market beta and that's that's all there is. Like when if you're investing, there is no such thing as
Investing acumen, you're just taking
Volatility risk in the market.
Charlie has a one word retort to that, which is
Bullshit. Warren goes through and and eloquently explains why that's wrong.
Well, and and they just have a lifetime of investment results to prove it. Like they actually can generate alpha, how well like otherwise you have to
believe that Buffett has uh has flipped a coin and it's come up heads, you know, a hundred thousand times in a row. Like it you're into these crazy probabilistic scenarios where
You know, at at some point it's too many standard deviations away from the mean for you to believe that it's possible.
Yeah.
And the reason
This is important for what's about to come.
Is
So like all this is theory, right? This is like economic theory.
But it has a
very, very important real world consequence in the eighties.
Which is that
People who
We 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 s certain degree of volatility
And then you lever the crap out of it with debt.
You magnify that volatility.
And then you can magnify your returns if you arbitrage that.
And so this is when you know
The eighties are the debt fueled.
Decade, you know. Mortgage backed securities get introduced. All the junk bonds and Michael Milken and DLJ
And corporate Raiders and corporate takeovers.
Are all happening.
Oh massive leverage buyouts. You get barbarians at the gate. Yep, Ardair and Nabisco, everything.
Yeah.
Buffett and Charlie are sitting and looking at this and they're like
Volatility being a risk is nonsensical.
Risk is risk that you go out of business and introducing debt into the equation
far from not changing your risk, it massively increases your risk because what causes you to
Get game over.
It's when you go bankrupt and you can't pay off your debt.
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.
So Buffett stepped off the board of the post to be able to do the Cap Cities investment. Cap Cities deal. So he invests five hundred and seventeen million in Cap Cities to help them buy
A B C
Five hundred and seventy million, like I mean that's a a big
chunk of money, but he can do this at Berkshire now. Like they're enormous. They're a multi billion dollar company. He's a billionaire himself already at this point.
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 um 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?
Well, a big part of it is
that five hundred and seventeen million in equity from Berkshire.
Coming in.
To the deal.
I see. So they 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. So I don't know I don't have notes on exactly what the structure of the deal was.
I believe it was
Some Cap City stock.
Plus the five hundred million
inequity from
I think it was convertible equity from um
Forks.
And then they probably did add on some debt as part of it. But you know, like a like a reasonable amount of debt. Like especially with a predictable cash flow business, you know, that
That's reasonable.
Where
Warren and Charlie.
Get themselves into
Not just like
Trouble on the order of
the the trouble with the feds earlier in the episodes, or actually the multiple troubles with the feds earlier in the episodes.
But real honest to God, like
Frankly the worst moments of their lives.
Trouble.
is when they think
That their reputation
And their ability 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. Or Wall Street from itself. Or Wall Street from itself.
With
Solomon Brothers.
Oh boy.
Here we go.
So remember we told you to remember John Goodfriend.
And Solomon Brothers.
Who had helped Gico.
Do
The convert deal.
That Warren back stopped.
You know, Warren.
Thinks good friend walks on water at this point. You know, they're the only bank that was willing to do this, you know, w Warren famously
And and Charlie, they famously hate Wall Street, they hate banks, but like
You know, okay, you did be a solid.
And and w we know these guys, so we feel for them a little bit. They don't they don't seem like the enemy. They're kind of our
Yeah.
We know them.
Yep.
So
We're now in the
Late eighties.
Good friend has become the CEO of Solomon Brothers.
They've gone through a series of mergers and acquisitions.
The firm is much bigger than it was before. It's now publicly traded.
And
Solomon.
Already was
The debt king.
But in this environment of the debt fueled everything we were just saying.
about the eighties.
Solomon is like
V
King.
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.
It gets
So extreme.
Uh Solomon.
That in nineteen eighty
I think it was eighty six.
A young
Princeton graduate.
Shows and aspiring writer.
Shows up.
At the firm.

Higher.
Michael Lewis.
On the
Bond sales and trading desk.
And ends up writing a book about his experiences intended to be as a cautionary tale of the wretched excesses of Wall Street.
Has the exact opposite effect called Liers Poker.
It's inspirational beacon for a generation of uh 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 it's just it's like the social network twenty years later. It's like you know, this was
Meant to be
Uh
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.
Great. I'll just read one quote from the book where Lewis writes about the famous forty first floor home of the bond traders at Solomon.
He says.
Because the forty first 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.
The place was governed by the simple understanding that the unbridled pursuit of perceived self-interest was healthy.
Eat or be eaten.
The men of forty one 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.
the limit of acceptable contact within Solomon Brothers.
was wide indeed. Here was capitalism at its most raw and its most self destructive.
I love Michael Lewis. I I could make every single one of his books a carve out at some point.
So great.
So
Despite
this immense success in
Yeah.
Bond market.
Solomon and Goodfriend have gotten themselves in kind of a pickle here.
Because it's working too well.
All these traitors, all these wolves of Wall Street.
They
Are generating so much money.
But they're demanding that they're gonna get paid all the money. So there's
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
Thick.
corporation itself, the you know, recently
Public, uh now public company, Solomon Brothers.
The profits are actually declining.
I was seeing some stat that
even in a year, I think it was in a year where they underperformed the S P five hundred, there were still over a hundred people at the firm that were paid out over a million dollars in their bonus.
Oh totally. Yeah. One year where that happened famously
one guy just individual trader made a twenty three million dollar bonus in one year.
And like
Nineteen eight.
Seven or something.
Right, which is I don't know, two two X, two and a half X uh uh by inflation today. Whatever it is, that's a
Damn lot of money.
For a rent seeker.
You know, like the where's the value creation there?
Oh oh there is only value destruction happening here. There is nothing being created. Or certainly value capture. Uh absolutely.
So
Because Solomon itself is
Suffering.
They start attracting the attention of corporate raters, and in particular Ron Perlman.
Revlon, right? Yeah, Revlon. Yeah. He buys out Solomon's existing largest shareholder.
And he starts agitating, like he's gonna
He's gonna take over Solomon Brothers, which good friend of c nobody at the firm because they just want to keep paying themselves the bonuses. They of course don't want this.
So
You've got basically
The a hundred percent most anti
Buffett and Munger, at least what they say.
Situation.
Possible here.
A bunch of people.
At the firm management.
quote unquote. There's no management going on, but like
employees just simply enriching themselves at the cost of shareholders.
While ratcheting up.
Risk
Hidden.
The economy.
And
Creating no value. Uh what could be better?
Good friend Calls Buffett.
He's worried about he doesn't want to get thrown out by Pearlman.
And he says he needs to cash in the favor from the Geico deal.
And
Warren, you know, at Berkshire has such a reputation of
being the white knight and saving companies at this point that and being management friendly. And being management friendly. Exactly. It's all gonna come back to bite'em.
that good friend says like, Hey, if I can get Warren to join the board, I'm gonna get
Pearlman off off my rear end. So
W Warren and Charlie agree to do it.
And
And they both take board seats, right? They get two seats. They both take board seats. So here's how it goes down.
It's Russ Hana weekend.
In September.
Nineteen eighty seven.
And Perlman is like a orthodox Jew. So he's
He's out of commission, you know, he's not
He's not doing anything over the weekend and good friend knows this.
And so he
Times everything so he gets the deal done.
In secret with
Buffett and Berkshire over that weekend.
Berkshire buys seven hundred million dollars of convertible preferred stock in Solomon, so more than the
money than they put into cap cities.
With a fifteen fifteen.
eighteen percent interest rate coupon.
On attached to that.
Convertible preferred stock.
So it's like the company's in dire straits and
The CEO really doesn't want or or really does want to incentivise these particular shareholders to become shareholders. Well, and that's what's so disgusting about this situation is like
the revenue line essentially of the firm has never been better. Like these traders you can say what you will about what they're doing, but they are raking in money.
For the top line.
But then they're paying it all off to themselves.
And bonuses. So the firm is suffering.
Capital's coming in. They do this
really tough terms deal simply to save
You know, again, quote unquote management's own skin.
It's it's really something that goes on here.
I don't I mean
It's crazy that Warren and Charlie and Berkshire do this.
Even
Yeah, loyalty is super important to them and
Good friend and Solomon having saved Gecko.
Anyway, they do it.
Both of them.
Join the board.
And there's this famous scene.
Where
They fly to New York, the two of them over this weekend.
I mean, this must be like on the Friday.
And they uh
They go to the Solomon building.
To sign the papers.
And good friend takes him on a tour.
They go to the balcony overlooking floor forty one. 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. I want me some of that.
And
They're looking down on what's essentially like a
Seething gladiator pit below.
And Charlie looks at Warren and he says
So you really want to invest in this, huh?
And Warren uh
Supposedly just is kinda like silent for a minute, you can just see him being like
What am I getting myself into? And he finally says
Mm-hmm.
In like a slow
And then he goes and signs the papers.
And
You know, credit to Charlie for asking the question, but Charlie follows him into the pit too and
And joins the board as well. Uh totally. And um
Probably regretted it every day after.
So
They do the deal. This is September
of nineteen eighty seven.
October nineteenth.
of nineteen eighty seven is Black Monday when the Dow falls twenty two point six percent. Oh my God. In essentially a flash crash. I had this confused in my mind. I thought
Black Monday in eighty seven was the long term capital management thing.
No, that happened much later.
This was actually a flash crash.
So like nobody really knows why
This happened. Of course the market was overheated. Of course there was way too much leverage in the system.
But
Things recover pretty
Quickly.
That's not what triggers.
A meltdown.
So Solomon of course gets crushed like
The rest of Wall Street, they lose seventy five million dollars in in trading losses.
On that day the stock gets crushed.
But.
They're not in any better or worse shape than any other investment bank.
But the stock is way down.
So Buffett and Munker show up to their first board meeting.
After this happens, which is like the next month maybe in November.
And um
Good friend in management.
puts a deal on the table to reprice
all employees stock options because the stock is down.
Um
Buffett and Munger flip. They're like, Wait a minute, you guys lost a ton of money for the firm.
Like we as you know
As shareholders in the firm, like
Our stock that we just invested, our seven hundred million is now worth less.
And you guys are saying you wanna
Take advantage of this lower stock price to reprice all of your options.
that you're then just gonna trade out of immediately as soon as they vest and liquidate for cash. Right. It's it's like it 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.
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 stock price drops even further. Stock price is gonna drop even further. They got seven hundred million dollars at stake here.
It's a
They don't really want to
Do that.
So
I mean, we're already pretty far down the slippery slope here.
This is when the real slide starts.
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.

Magical Arb Desk. The
Bond arbitrage desk.
Run by John Merriweather.
Who runs the domestic fixed income.
Arbitrage group.
Two
directly pay them
Fifteen percent of all the trading profit.
They make as bonuses.
So like
No longer even just to like, hey, management will decide your bonus at the end of the year. It'll be based on the performance of the firm.
It's now like
You're a prop shop. Like fifteen percent of all of your
Profits.
You're gonna take home.
With none of your own capital at risk.
And
On the hook for none of the downside when you have losses.
Wow.
Yeah, I'll I'll incentivise some bad behavior. Yeah.
So things limp along for the next couple of years.
Warren and Charlie aren't.
Thrilled about everything that's going on, but
So then.
The shoe drops.
In August of nineteen ninety one.
Buffett is on vacation.
In Reno, Nevada.
And he gets a call.
From
Not from good friend.
from Solomon's president, Tom Strauss,
And it's general counsel.
Don Frerstein.
Who
Behind the scenes at Solomon, Don is referred to as quote.
The prince of darkness for all of the dirty work Things I never want to be called. Yeah. That he all of the sticky situations that he gets Solomon out of and all the dirty work he does. This is amazing. You can't make this stuff up.
So Warren's on vacation he gets a call. This is not a call you want to get.
And uh
Uh so warren's suspicious.
And they get on the phone and and they're like, Well
Our firm's outside council, Solomon's Outside Council, has figured out that
the head of our government bond trading desk, Paul Moser, who reports to Merryweather
He's apparently been violating some of the Treasury Department's rules when bidding on
Government bond auctions.
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 by the debt.
And there's only a few, w what is it, forty 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 US government.
Yeah, this is the way.
the money supply gets into the economy.
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.
So
Moser's been
violating the rules.
And that they've suspended him and Solomon is gonna, you know, notify the regulators about this.
More it's like oh.
The Prince of Darkness is calling me for this? Like
That doesn't seem to be.
That bad. Like you violate some rules, okay. But like
While this is really important and prestigious, this is like kind of a sleepy part of the firm. You wouldn't think that
the government bond desk is something that could like blow up the firm. You know, you'd be more worried about
The Arb Desk.
Per se.
Mm-hmm.
So he's like, All right, well, you know, call Charlie
He's the lawyer between us, you know, he'll he'll know what to do. J just some rules, like how how bad could it really be?
I'm sure it's just some regulatory tape. Some regulatory stuff.
So they're like Oh yes, we've we've already talked to Charlie.
He's totally cool with it. Like
No worries. So I'm like, Okay, great, I'm gonna go back to vacation.
Well, turns out Charlie wasn't totally cool with it, and turns out that maybe Moser did a little bit more than just violate
The treasury is
Bidding rules.
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.
So on behalf of people who weren't even
Customers of
Solomon Brothers.
And his goal in doing this is
was to essentially corner the market in this auction.
When
All of the auction for
Please.
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 send
sell it at a massive profit in the market.
Which he
Did you get it?
And of course
While it's illegal to bid on behalf of your clients who are not placing orders, and then 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 option. There are rules in place that say things like you can't
try and bid for more than thirty five percent 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
You know,
paying a big premium'cause someone managed to go get ninety percent of the allocation.
Totally. And
The reason they don't want this to have happen is what actually happens as a result of
Moser's actions.
Oh, like three or four.
small financial firms that couldn't absorb
Does price volatility go bankrupt?
Uh so this is like
This is real, what the dude did.
And I think
He did this like four or five times.
And
The net of all of it was Solomon made an incremental four million dollars in profit. All this for four million dollars.
So it turns out he did it multiple times.
It turns out that
Merryweather.
Who was his boss in the chain of command.
And good friend knew about this four months ago.
And they knew about it because the SEC started investigating
And got in touch with them.
And when that happened
the general counsel, the Prince of Darkness,
Told good friends.
Yeah.
What was happening here was criminal.
But that technically
They didn't have any technical obligation to report it to anyone.
sending letters to the general counsel without notifying the board. Like, hey, I got this letter from the SEC. They're investigating us.
But
Just our G C needs to know about it. Yep. Not notifying the board, not notifying the shareholders or the public.
And equally
If not worse.
Not
notifying the other regulators that this is going on. So the SEC is investigating, but they haven't found any. They just found some irregularities.
Internally Solomon found oh no, this is criminal, like what's going on here. So they don't tell anybody.
And not only that.
They don't
Fire Moser.
They leave him in place.
Running.
The government bond desk.
And
There's no audits or controls on what he's doing. So basically they're like
Don't do that again, a wink, wink, wink. Wow. And then
They turn.
Around and look the other way.
So
At this point in time the SEC has like figured out like
Yeah, these aren't just irregularities, they figured out what's going on.
Word starts to get out.
On Monday after this
August twelfth.
The Wall Street Journal runs a big piece about
How
how bad this could be and how little is known.
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.
And
Solomon, it turns out, they're the second biggest bank on Wall Street at this point in time.
They have a hundred and fifty.
One five zero billion.
Of capital.
Like in the markets.
Wow. But they only have four billion dollars of equity. All the rest of it is like
short term paper and debt and leverage and like everything that has been building up in the eighties.
So they're like
What's that?
Sixty times levered on their
Oh my god.
And all of a sudden their counterparties start getting cold feet about
Trading their paper.
And fifty billion, five zero billion of the hundred and
Fifty billion rolls over every single day.
That's really short term paper. So if there's a problem
It's gonna be instantaneous and the firm is dead.
So
Also on that same day on that Monday.
This is probably the worst thing that happens.
So the Federal Reserve sends a letter to Goodfriend and Solomon.
Saying I think only good friend and and uh the general counsel see this.
Saying that it is quote deeply troubled, but
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. This is the Federal Reserve.
Unless the firm responds

And significantly changes its business practices within the next ten days.
Now.
If the Fed ends its business relationship with Solomon.
Game over. Like it's dead. All the counterparties are gonna stop.
Trading with Solomon. Wow. Like it's it's literally game over.
Instantaneously.
Good friend and the G C
Just sit on the letter. They don't tell the board.
They don't tell anyone else.
They don't tell the show. Nobody knows about the letter except the two of them.
The Feds assumed that the board knows.
About the letter that like Solomon is doing something.
But good friend and and the D C cover it up.
Buffett.
By this point in time, he gets in touch with Charlie and Charlie's like, uh
Yeah, you should be concerned about this.
So the board convenes, they issue a press release.
saying that, you know, they're looking into this and
Figuring out what happened.
the firm's stock drops thirty percent.
That day.
The Fed, meanwhile, is like
You guys aren't responding to our letter. Like
Oh, they're just getting angrier and angrier every day that goes by.
On
Friday of that week.
The New York Times runs a headline.
Wall Street sees a serious threat to Solomon brothers.
And
The Fed finally has had enough. The lead in investigator running the case at the Federal Reserve calls a good friend and says
You need to resign.
Like today.
And you need to install new management.
Or else, you know, essentially.
When Goodfriend gets that call.
He calls Buffett, who's still in Omaha.
And he essentially just tosses him the keys to the firm and he's like
I'm gonna resign.
Somebody has to step in and um
Run the place and deal with this.
It's probably gotta be you.
So good luck with that. Wow. Not quite in that language, but uh but that's essentially how it goes down.
Pretty intense stuff.
Well, Warren and Charlie are
Legitimately.
Frightened at this point.
And the argument there is like hey
I have to be out.
Uh we don't have any ideas for who's next. Yep.
There's no plan. There's no management. Whoever steps in has to have the reputation to be able to save this firm and like
Nobody wants their investment to go to zero, so I pick you as the person who seems like you might uh uh be able to save this thing.
Well, at this point
the fiduciarily responsible people are the board.
And who are the most prominent people on the board.
Warren and
Charlie, and Warren specifically.
So like
You know, w good friends already out.
L Cow.
So there's nobody left except
Warren to
Wild.
Deal with this. So Warren i immediately gets on a plane to New York.
And he goes and
meets with the Federal Reserve.
And tries to like understand it. Sweet talk them.
This is uh amazing to me.
The Fed, I think, assumes that
Warren knows about their letter.
But he doesn't.
And that wires still get crossed in this meeting. So Warren doesn't understand what the worst case scenario really is.
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 gonna yank
The right to, you know, participate in the treasury auctions and Solomon's gonna go down the tubes.
So now
It's Friday night into Saturday morning and Warren has to make a choice.
He can
Walk away.
From Solomon.
Say I'm resigning. And and seven hundred million dollars goes up in flames.
But he can walk away.
Or the other option is he can take the reins of the company and try and
Steer this thing through.
As he's thinking about it and talking with Charlie, he realized he he actually
Doesn't have a choice.
Because
If he walks away.
His reputation is toast.
If he walks away a hundred percent his reputation is toast. And like he loses seven hundred million, like that'll be fine, but like what company is gonna do a deal with Berkshire Hathaway?
Ever again after this. Right.
And if he stays
You know.
Probably there's a good chance he's not gonna be able to navigate through this.
In which case his reputation is also toast.
Which th this brings up that George Bernard Shaw quote that I think it's Charlie who likes to quote it.
Never wrestle with a pig. You just get dirty, but the pig enjoys it.
Exactly.
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.
Yeah.
And this is where
As he's realizing this.
So Alice writes in the snowball.
Yeah.
At some point during that long, horrible Friday, he recognized with a sickening jolt the
That investing in Solomon
A business with problems over which he had essentially no control.
had put it all at risk. And by all she means
Everything. Not just the seven hundred million in Solomon, like
Everything that Warren
And Charlie together have built. You know, they're both on the board.
So he decides he has to take the job.
He decides he's gonna become interim chairman of the company.
And he installs the
Head of the investment banking division.
A guy named Derek Mann as the CEO.
That's just kinda like a
I mean the investment banking just that was the one thing that Solomon was not good at was the investment banking advisory in business. So he he gets installed simply because he's just far away from all the toxicity.
And uh
Then
On
Sunday.
the board, Warren and the and Charlie and the whole board is at the office in New York. They're trying to figure out what to do.
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 gotta happen. And thus far nothing has been announced from Solomon.
So they say they've had enough.
It's the end, like no more negotiating.
They're pulling the plug that afternoon.
And by the time the market opens in Tokyo.
Which is like I think late afternoon New York time.
Uh, this is Sunday afternoon, so Monday morning Tokyo time.
It's gonna be announced that the Fed has revoked Solomon's
Licenses.
And it's over.
So
Warren.
directs the board and the lawyers to start preparing a bankruptcy filing.
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.
Yeah.
He finally reaches the
Treasury Secretary Nick Brady.
Which was the the Treasury and the Fed jointly made this decision.
And
literally like breaks down on the phone crying and like
begs him, uh 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.
And so Brady is like
moved by this. Uh 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 gonna do.
So
Hours go by.
It's all in limbo. And they're just sitting in in the Solomon office.
Drafting up a bankruptcy filing.
And then a call comes in.
From the assistant treasury secretary.
Do you know who that was?
At the time.
Call comes in for Puffett.
No.
One Jerome Powell. Oh my God. Then assistant secretary of the Treasury.
Incredible.
And uh
He says
Like.
Well, like this is bad.
We're not gonna allow Solomon to bid
itself in treasury.
auctions anymore. So we are gonna
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.

Mm.
Unbelievable. That's insane. So now they have to deal with the aftermath. Also, it's incredible that Good Friend never showed the letter because
I assume he was a shareholder too, and of course it's gonna come out that there was a letter set at some point, so it's not like he's saving himself any
Like legal liability by not disclosing it.
Well, I think what happened I don't know how far in advance he had
Gamed this out.
What ends up happening
I'll tell the story in a minute of how this all wraps up, but
as this is going down like concurrently that weekend.

They end up'cause War Warren still
But he doesn't know the extent of good friends.
You know.
Deception here and cover up.
And he doesn't know about the letter. He doesn't find out about the letter until later.
And so they go out to dinner.
And uh good friend and his lawyer.
Uh personal lawyer.
Try and get
Warren and Charlie to sign a severance package.
For him.
Leaving.
The company uh they want a thirty five million dollar payout.

Oh 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 w 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. And so he was just muttering and not saying anything. And it's uh
Amazing. In the negotiation. Yeah, in the negotiation. So they don't agree to anything. They don't sign anything and
E ends up after years of
Fighting this in arbitration, uh, get zero dollars.
As he should.
Anyway.
So
They get the save.
The stay of execution from
The government.
And then they have to deal with the
Aftermath.
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. So he instructs Mon, the new CEO,
To clean up.
The firm inside. You handle everything inside the building.
And his instructions are
Get it right, get it fast, get it out. In terms of dealing with all the corruption in Solomon.
And basically the first thing that happens that week is he gets Warren gets summoned before Congress to go
Testify in front of Congress.
And
This is brilliant. So they bring in
M T O, Bunger, Tulson, uh and Olsen.
Of course, to represent him and all this and and Roy Olson.
Comes in.
And Roy suggests
This brilliant step.
That
Goes a long way, I think, towards the
Saving Warren and Solomon.
He suggests that they proactively
Go to the government.
And say
We will waive our attorney client privilege.
So
Everything. Which is this is like extraordinary. This never happens.
So they're going to the government and they're saying
All of our communications and anything that MTO
Fines at Solomon.
We will share with you. Wow.
And you as it makes sense to do that because they're the new guard. So it doesn't there's no way it can reflect poorly on Warren, Charlie, MTO
It's only gonna be
negative for all the people that
Warren wants to fire anyway. Exactly. So Alice writes in in the snowball about how perfect this was.
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.
And the employees, meanwhile.
must cooperate or be fired since
None of anything that they would say would be protected by attorney client privilege with MTO.
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.
Yeah, so Warren's not there to protect anyone. He's there to uh uh this is a win win for Exactly, exactly. This has Charlie's fingerprints all over it.
Huh.
So Warren goes in front of Congress.
Probably one of the
Most famous statements
that Buffett's ever made and uh
You know, certainly corporate history.
Where
He's being grilled by senators.
About what he's gonna do.
And now he's gonna turn it around.
And he says uh
The way that Solomon's gonna 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.
Hmm.
Fascinating. And he kinda puts on a show and he wows.
Congress.
And Solomon ends up getting out of this thing.
With they settle
In the next few months with the government for a
one hundred and ninety million dollar fine
Plus a one hundred million dollar
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 auction? It's gotta be it.
Yeah.
Certainly that's a lot of money, but like
This is amazing.
He pulls this out. The firm survives.
And so obviously Solomon is, you know, damaged, but over the next few years
They recover.
And
They end up a few years later. When does Warren when's he able to like actually step out of day to day as soon as possible. Basically as soon as the settlement hits, he's like and I'm out as chairman. He stays on the board, though. He keeps the investment in.
Yeah, but he's no longer.
Day to day.
So this happens in
Ninety two.
Six years later, in ninety eight.
Solomon gets acquired by
Citigroup, the former traveler's insurance.
as put a pen in for nine
billion dollars.
Which means that
Brooks.
gets a a return of one point seven billion dollars on their seven hundred million dollar investment plus
The fifteen percent.
Coupon that they had been catching. Coupon that they've been getting.
So
Unbelievably.
I mean
It it literally takes
Warren and Berkshire to the brink.
But this ends up being a really good investment for them.
Wow. It makes so much sense why he Buffett then had the the quote, It takes twenty years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.
I I bet he sort of imagines looking out on the training floor when re reflecting on how he might do things differently.
Totally.
I do wonder if he looks back on this and thinks was it worth it for that investment return? Probably not.
A hundred percent not. Yeah. A hundred percent not.
You know, the irony is like
Yeah, a hundred percent not.
But this only kinda adds to the myth of
Warren and Burkshire.
He can he can save even the Cesspole of Solomon brothers, you know, what can't he do?
What can't he do?
Uh so
This is where we're gonna leave.
Part two.
But there's one coda.
Before we do.
Ben, y you may know, you probably know, but listeners
I will ask.
Do you know?
What
Other organization.
After this whole debacle.
That John Merriweather
The head of the
Fixed income.
Trading at
Solomon Brothers would go on to found
Two years later in nineteen ninety four.
David, is it
Uh something that had a crisis where you mentioned it earlier in this episode.
Yes, it would be.
My God, this is just crazy.
Is he
Part of the group that
was the former Solomon Brothers people that went to do long term capital management.
Not only was he part of that group,
He was the leader of that group.
Literally John Merriweather.
Founder and CEO.
Of long term capital management.
Wow. 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. Wow.
Yep.
How
Crazy is that.
Did any of these guys ever go to jail?
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.
Uh
Isn't that unreal?
Wow.
Like literally
I mean uh 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.
But they were also scared too. Like 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
A financial meltdown and then
Of course.
You know.
Sixteen years later, we got to
That was this was the dress rehearsal for what we got to see.
Actually happened in two thousand eight.
Wow.
Which of course
Burkshire also, uh
Was an active participant in.
Yeah.
Mostly mostly in buying the dip.
Yeah.
But uh well, we'll we'll save that story. It's funny, we've got for part three, we'll have the whole tech bubble. We'll have
Two thousand eight.
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.
But this feels like a good place to leave this part.
Yeah.
I mean, we intended this to be one episode on Berkshire originally and uh
It's like the the deeper we go into it.
As we were doing the research having this this Solomon episode. I knew that this had happened.
I didn't know.
that this had happened. No. I mean the only thing that I really knew is that uh 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. But like
That is really true. Like that alone
It's not just like that he was
Acting
As
the head of the bank in a riskless way. Like
He risked the whole future of Berkshire.
To make this happen.
Yeah.
In fact, when when you when you think about the return turning seven hundred million into one point
What or he made one point seven billion over how many years was that? Like six or seven? I think he made a it was a billion. So I think it was seven hundred million in and then
One point seven.
Oh.
But he got the coupon payments also, so
So it's maybe like a two hundred percent return over
Over six, seven years. So good, but not w for this risk. Yeah, no, definitely not for this risk.
Wild.
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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. Cause 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 seventies and eighties and and owned outright.
Sees candy.
West Co financial.
The Buffalo News.
Precision steel warehouse, Nebraska furniture mart, takes this B.
Scott Fetzer.
Feckheimer brothers.
Borsheim's jewelry.
H. H. Brown.
Central States Indemnity.
And then in ninety five, the the finishing touch on on Geico, they bought Hellsberg Diamonds and uh R C Wiley home furnishings.
So there's like a lot of Berkshire that you think about today that they don't own yet.
Yeah.
On the public equity side, the main
positions we talked about
The post.
Capsides.
Solomon Brothers.
And one that we didn't talk about that we'll talk about more next time in Coca-Cola.
I think those represented significant parts of the value
But again as we've seen.
They're taking a hands off approach here.
as we analyze the power, we think about them as sort of two different business lines.
'Cause it does feel like it the 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 twenty twenty, you have Ted and Todd.
uh 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 you know wholly owned subsidiary side.
The insurance and the
Jeep running the insurance businesses and
Greg running all the non insurance businesses. Non-insurance, which is funny because it's like so diverse that you don't have a way to label it. So it's just insurance and non insurance. Yep. So okay, let's talk first about the wholly owned businesses. So
The business activities there are
Prospecting
you know, identifying the whole landscapes of b 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 to, you know, make those businesses hum over a long period of time.
And then of course
capital allocation where you're 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 in growth, or if that's a capital producer and you maybe like uh your your jacket linings business or your
uh your stamps business, you don't want that business consuming any more capital, and that should just spit off capital that gets sent to the head office for reallocation. So with that preamble
Those are sort of the business activities of the whole owned subsidiary side of the business.
Yeah.
now of the Hamilton Helmer Powers.
which uh you know basically enable you to in a long term way get a durable, sustainable
differential profits above your nearest competitors. So here I think we should think other conglomerates.
We should think private equity firms. Definitely private equity firms.
Yeah, think about uh the these companies going public. SPACs weren't really a thing yet, so that wasn't uh an option on the table. Strategic acquirers, I think, were though.
The question is which of the seven powers sort of applies to Berkshire?
Yeah.
This is gonna be fun.
'Cause it's not network economies. It's not our it's not our usual favorite.
It is definitely not. I'll make a first run at it.
And say counter positioning.
And certainly counter positioning versus anybody that's running money.
Yep.
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.
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.
And you're not getting a carry or a promote.
you have just as much downside risk as upside benefit.
And so you're
Incentives are
pure in a way. You only want to make financial decisions that
You know, buy low, sell high, or buy low, hold forever.
And uh uh there's no other way that you make money.
Well, all your only focus is
Long term.
Value creation.
Because nothing that you're gonna do is it gonna increase your fees or increase
Your
value in any set, you know, fund life period of time or anything like that.
Right. So that makes you counterposition to private equity firms. Yep. And so then the question becomes
Is that actually
power in a positive way? Or is it
Somewhere.
negative? Is it just a disadvantage? Are they counterpositioned to you? Because
Let me put it this way.
deals that a PE firm would do that Warren wouldn't do because the price is too high.
But it
Is the opposite true? Can Warren get deals done
Because the PE firms have an opposite business model?
Well
It's interesting, right? Because this is
So obviously not a tech company in so many ways.
And
This m market.
That Berks are operates it in the market of
acquiring in and investing in other
Companies.
Is not a winner take all market.
So what's interesting is like
To succeed they need a niche.
And
They certainly carve out their niche.
Exceedingly well with counter positioning versus.
Other players.
The best you know, we didn't talk about this on
The episode.
I'm gonna say'cause we didn't have time, but like well, what is time on an acquired episode anymore? But uh this is how they win the mur the Mrs. B deal, the furniture mart deal.
You know Buffett sits down with Mrs. B and
says to her,'cause she has other offers to buy
the furniture mark for more money.
And says.
You know, you
You could certainly take those offers and I'm not gonna pay
What.
the private equity firms and others will pay.
But
At the end of the day, those
Firms.
Oh.
What's motivating them?
Is
Selling.
your business for more money. 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.
But at the end of the day.
They're gonna do anything to maximize them.
selling the business for more money within a set period of time so that they can make
Their fees.
I'm not gonna do that.
I'm genuinely gonna leave you and your family to run this.
Right, it's like having a longer lens.
is actually the counter positioning here. Yeah.
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. Yeah.
Both of which are true.
Both of which can be true. Can be true. Depending on uh if you acquire the right business.
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 low up the companies to buy them.
If the goal is

Operate.
Sustainably.
Top.
longest and generate the most cash flow over truly the longest period of time.
You don't want to use debt because debt is gonna increase the chance that the company goes bankrupt.
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 or just for the legacy of the business.
Your interests are aligned with Warren's, then.
Because
He wants the lo cash flows over the longest period, which means he's gonna avoid debt.
Such a good point.
Mm.
Okay, so yeah, I agree. Counter positioning for sure.
Definitely branding.
Definitely. I mean like that's probably actually the place where you start.
Like the Warren Buffett brand just enables you to do things that like
Literally the Solomon thing. 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. Totally.
It's trite, but I'm trying to use the the seven powers language here.
Uh a hundred percent. I think the seven powers actually apply a lot. Yeah.
Counter persisting apply, but yeah, branding. A hundred percent.
Like Warren.
Buffett and Berkshire Hathaway's money.
Is worth more.
than the equal amount of money.
From somebody else.
Yep.
Absolutely.
Okay, so I don't think there's necessarily scale economies. I mean, maybe you could argue a little bit that like the scale of the insurance businesses in the float enables more investing, which enables more operating businesses, which enable you know.
Mm, maybe. I think that's a little bit of a stretch.
During this phase, uh 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
you know, nothing else moves the needle for you enough. But during this period in the eighties, 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.
Yeah.
Yeah, actually that that's a really good point.
That's a good point. It's a power right now
But it's not a like sustainable power.
Yeah. Oh that's interesting to think about.
Okay, I don't think they're switching costs.
No, I this and that's all I've got for this so far. The question is which of those apply to the public investing side of the house?
Ooh. Well the one I was gonna talk about
I always have such a
hard time thinking about this power.
And as Hamilton says it is the trickiest of the seven powers, but
Is there process power here?
Apparture.
I mean, it's funny it's like thinking about process power in a super small organization feels like a de facto no.
'Cause the the he always uses the example of the Toyota production system that like the system was so complex it couldn't be written down to be retaught to someone else'cause it's held in so many heads and
the decisions are all made by one person. So like is there process power in Warren's head?
Well he calls Charlie.
But Warren ultimately makes the decision.
I think there's a liberal interpretation of process here to to make that
The case.
It's funny'cause I was if for public market investing, I was thinking like
Okay.
That might be the only really
Arguable one.
You
Freaking efficient market hypothesis to you.
Well,
Uh no, I'm definitely not an efficient market uh hypothesis disciple.
But I do I think there are definitely market inefficiencies as this episode shows.
But I don't know that
Burks sure had any sort of unique
any defensible ability versus others to
See and then act on them. They acted on the ones that they saw.
Other people could act on the ones that they see.
Right.
But getting back to that point that I made earlier.
Around
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.
I think I was sort of foreshadowing power there.
Where
there are things where Berkshire uniquely could have acted.
And therefore saved the company, gotten the deal that they did, were able to join the board, whatever the thing is.
And so I'm trying to figure out how to quantify that.
So WAPO
Solomon Brothers, these were things that
Buffett could uniquely do in an advantaged way versus the com their competitors uh their competitors being all other capital and why?
Well WAPA was kinda
Buffett had to fight his way in.
It was sort of like maybe that was like part of developing
This power.
'Cause you know
K was sort of like scared of him at first.
And certainly reluctant.
And then
Buffett fights his way in.
I don't know that like
That was a power. But then once he was on the Washington Post board
And like the mystique of Warren Buffett had started to
To grow.
Then I think maybe it becomes
Something defensible.
Yeah.
That's a great point.
Well
Normally here I would move us on to playbook.
I literally think we had discussed every playbook theme.
During the narrative, during history and facts.
uh that I possibly could have brought up here. So I have
Nothing to add in the playbook section this episode.
Yes.
As as Charlie would say.
No.
Nothing to add.
Value creation versus value capture.
Let's do it.
So
Buffett definitely created more value.
In this
chapter than in the previous one.
Like the previous one, you're buying and selling
You're buying at low prices, you're selling at high prices.
Here you're doing things like they legitimately created value for Solomon's shareholders.
Like a lot of things. Created nine billion dollars worth of value.
The question is w what other situations in the seventies and eighties did they create value?
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.
I think they also created value for Gaigo.
In the
Saving Gyako now, you know, Jack Byrne did all
All the legwork himself.
But
No question.
Having
Warren
Yeah, uh there
Both with the regulators and the government of like
Hey.
Bricks or Hathaway is behind us now, we're gonna be okay.
But then also specifically with the financing and with
Solomon Brothers in with Wall Street.
You know, backstopping the deal.
Yeah.
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.
That's a good question.
I don't
Thank you
So
I mean, how hard is it to go get different insurance?
Right.
And
If Geiko wasn't gonna make it if they didn't make those changes.
Right. It's not like they corporate ratered it and went in and it was gonna go perfectly fine, but then they destroyed it. Toys are us style. Now what was interesting in that
Story though was
You know, I think
Gyico and
Burn.
were the first to actually pull out of states. Like nobody had ever done that before. Uh so they did sort of cross a Rubicon.
So yeah, I don't know. It's a good question.
No.
Certainly Solomon Brothers.
Y y you could
Debate.
A lot of value destruction there in aggregate.
Oh, from the entire time they were shareholders, certainly. Yeah.
Now did Buffett
Yeah.
Burkshire.
Meaningfully contribute to that.
No, probably not.
Other than they
Did prop up corrupt management.
Yeah.
Like value capture.
To move on to that and hit it real quick, uh it's Berkshire, it's Buffett, they always do a damn good job of capturing the value they create.
No qualms there. Yeah.
Interestingly, especially
over this period in the life of the company, probably because of the long term
Focus on not selling investments with regard to
Tax liabilities.
Yeah. Berkshire.
And its shareholders pay.
If you don't sell, you pay no tax.
Right. Massive tax deferrals. Massive tax deferrals, yep.
Alright, grading.
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 five hundred during that same time frame.
And you you may recall that in the Buffett partnership years, the annualized return was a twenty nine point five
Percent.
annual return over those twelve years. Historic, legendary.
And and I think what did we determine that was? Something like a
Twenty eight X.
And you actually that that twelve years you could comp nicely against a venture fund and say
Yeah, if anyone could twenty eight X the money.
then they'd be a top decile fund for sure. And uh the Buffett partnership had the
Increase benefit of you could
take all your money out or put all your money in in any given year.
You didn't even have to lock it up for the entire life of the fund the way that a venture fund does. So uh you know, slam dunk, I think we call that an A or an A plus.
This set of years we're gonna look at nineteen seventy, so the year immediately following the liquidation of the partnership.
To nineteen ninety two.
And we're gonna look at just Berkshire Hathaway.
over that stretch of time.
Their rate of return.
Pretty similar.
Twine point four percent.
Dang.
Like
I don't know how you like the Buffett partnership years and don't like these. I think this is like Yeah.
This is the golden years of Berkshire Hathaway.
Totally. Wow.
I didn't realize that that's
What
The number was. I mean, it literally is it's just like Michael Jordan, you know? He went out at the top of his game.
He came back and he won three more championships.
And then he went to play for the Washington Wizards.
Yeah.
And actually maybe we will see that last part here in uh
Forgetting to buy tech stocks in the next next chapter. Yeah. But truly, I think
There's this scary thing where you sort of look at this and you're like
Maybe Buffett does know how to time the market.
Like no one can
And yet the guy liquidated his partnership in sixty nine
bought back in big in seventy one, seventy two.
had this run all the way through
you know, the early nineties.
Started
piling up cash in the nineties, and as we'll talk about, wrote a very famous article in ninety nine
you know, the year before the the dot com bubble burst.
articulating exactly how overheated everything was as he was piling up his cash. So he is acting on his thoughts here.
Uh maybe he can time the market.
Maybe.
Although
Well.
We'll save this for part three, but I would say track record on market timing has not been great of late.
No.
But just to put some numbers around this twenty seven point four percent uh rate of return.
If you had bought
Berkshire in nineteen
Seventy.
On January first, which is uh the day that
Buffett distributed it out to everyone when he closed down the partnership. Uh, it was forty five bucks a share.
And at the end of nineteen ninety two, and and of course these are what we now call the A shares.
In nineteen ninety two
That was eleven thousand seven hundred and fifty dollars a share.
Wow.
Bonkers. Bonkers.
And today it's over four hundred thousand?
Is that right?
Yes, it is a record high as of last Thursday and may maybe up again again this week.
Wow.
My hat is off.
What more can you say?
All right. What more can you say except like
The comparison is Michael.
Yeah. Well
Listeners, we will know more in part three, and thank you for uh listening to the Empire Strikes Back episode of the Berkshire trilogy.
David, you want to do quick carve outs? Yeah, let's do it.
So my carve out is a
Great.
podcast episode on the Armchair Expert Podcast.
Which is so good.
So good.
Dax and Monica do such a good job. So many good episodes recently, but
Seattle Love the Macklemore episode.
Was amazing. Have you listened to this?
No, I haven't. Oh, you gotta listen to it. It's so great.
Lots of Seattle talk.
Dax left Seattle. He recently was in Seattle, so they they spent a lot of time talking about it, but
McLamar was so great.
They just get into so much great stuff.
Lots of discussion about
Uh, just ever just go listen to the episode. It's fantastic.
All right.
Just added it to my queue, literally pulled out my phone and added it to my overcast queue.
Mine has its roots in uh something that you said earlier this episode. You mentioned the mafia, you mentioned the state of New Jersey.
I for the first time am watching the Sopranos.
And it is excellent. And I
Totally see how it kicked off this like modern
golden era of T V that we have going on.
And I think um
Uh it was lost on me. I I mean I was
what, nine when it first came out, or ten 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 uh 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 in many ways, but God is the writing great.
So great. So
Can't recommend it enough. I am in season six A, so I am nearing the finish line. So nobody spoil it for me. Amazing.
What year did the soprano start?
I wanna say it was like ninety seven, ninety eight. It was like right around the time the Matrix came out. Wow. Oh man, that's a throwback.
Yeah.
Matrix.
Wow.
And they share a couple of actors between the Matrix and that, which is it's it's 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 and I'm I'm feeling
quickly like my parents. Like w when I was a kid, I remember watching things with my parents and they would say, Oh my gosh, this movie has young so and so in it. And I uh that's now me.
That's amazing.
That's amazing. Well
We're hitting that time of life.
We are
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 uh we may not have seen in the research. 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.
Join us in the Slack. Acquire dot Fm slash Slack.
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