The Snowball: Warren Buffett and the Business of Life

by Alice Schroeder

Some Internet stocks traded at infinite multiples of their nonexistent earnings, while “real companies” that made real things had declined in value.

“This is half of a page which comes from a list seventy pages long of all the auto companies in the United States.” He waved the complete list in the air. “There were two thousand auto companies: the most important invention, probably, of the first half of the twentieth century. It had an enormous impact on people’s lives. If you had seen at the time of the first cars how this country would develop in connection with autos, you would have said, ‘This is the place I must be.’ But of the two thousand companies, as of a few years ago, only three car companies survived.21 And, at one time or another, all three were selling for less than book value, which is the amount of money that had been put into the companies and left there. So autos had an enormous impact on America, but in the opposite direction on investors.”

“Now, the other great invention of the first half of the century was the airplane. In this period from 1919 to 1939, there were about two hundred companies. Imagine if you could have seen the future of the airline industry back there at Kitty Hawk. You would have seen a world undreamed of. But assume you had the insight, and you saw all of these people wishing to fly and to visit their relatives or run away from their relatives or whatever you do in an airplane, and you decided this was the place to be. “As of a couple of years ago, there had been zero money made from the aggregate of all stock investments in the airline industry in history.

“My whole life flashed before my eyes, because I didn’t know what to do with the echo. They hadn’t prepared me for this. Paralyzed—my big moment.” Should he copy the other trumpet player’s mistake or embarrass him by contradicting what he’d played? Warren was undone. The scene scalded itself permanently into his memory—except for what he did next. Years later, which course he followed—assuming he played any note at all—had become a blank. He had learned a lesson: It might seem easier to go through life as the echo—but only until the other guy plays a wrong note.

“I am God’s child. I am in His Hands. As for my body—it was never meant to be permanent. As for my soul—it is immortal. Why, then, should I be afraid of anything?”1

Everybody wants attention and admiration. Nobody wants to be criticized. The sweetest sound in the English language is the sound of a person’s own name. The only way to get the best of an argument is to avoid it. If you are wrong, admit it quickly and emphatically. Ask questions instead of giving direct orders. Give the other person a fine reputation to live up to. Call attention to people’s mistakes indirectly. Let the other person save face. I am talking about a new way of life,

“I learned that it pays to hang around with people better than you are, because you will float upward a little bit. And if you hang around with people that behave worse than you, pretty soon you’ll start sliding down the pole. It just works that way.”

Until 1958, his straightforward route was to buy a stock and wait for the cigar butt to light. Then he usually sold the stock, sometimes with regret, to buy another he wanted more, his ambitions limited by his partnerships’ capital.

“He’d always praise you while he gave you more to do.”31

It was much the same at home. Buffett would tell someone with great sincerity, “Please come visit, I really want to see you,” then bury his head in a newspaper when they arrived, apparently satisfied with their presence. But there was also the odd chance that he wanted to talk and talk, and they might go away exhausted.

“Wattles had this little closed-end investment company called Century Investors. He did this chain thing where he would be buying stock in a company at a discount, which would be buying stock in another company at a discount.…

“We bought it at a discount from its asset value,” says Munger. “And there were two assholes who were the sellers. We had a no-asshole rule very early. Our basic rule has always been that we won’t deal with assholes. And so Warren, when he heard about Source Capital, said, ‘Now I understand the two-asshole exception to the no-asshole rule.’ ”

Berkshire’s portfolio looked as though someone had given it a severe hedge trimming, shearing off nearly one-third in the second Great Crash, the kind that comes along only a few times in a century. Munger had kept his partnership open after Buffett had shuttered his. Now its value was plunging, his partners losing nearly half of their money.

The partners who took Berkshire stock in 1970 when it traded around $40 seemed no better off five years later. “It looked like not much was happening favorably for a long, long time,” says Munger. “And that was not the way our partners, by and large, had previously experienced things. The paper record looked terrible, yet the future, what you might call the intrinsic record, the real business momentum, was gaining all the while.”

The workers got a paycheck for the time and effort they put in—no more, no less. A deal’s a deal. But after everything they had all been through, the staff was stunned at his lack of empathy. As Buffett and Munger left the office, Munger walked past publisher Henry Urban, who was “waiting for at least a small accolade,” said Ron Olson. Munger was famous for getting into cabs while people were talking to him as if he did not hear them and for disappearing through doors the second he finished talking without waiting for a response. Nonetheless Urban stood open-mouthed. Buffett followed along right after Munger without looking at anyone. Nobody said thanks. Olson, following in their wake, moved around the room shaking hands in an effort to make up for it.37

The method was the same: Estimate an investment’s intrinsic value, handicap its risk, buy using margin of safety, concentrate, stay in the circle of competence, let it roll as compounding did the work. Anyone could understand these simple ideas, but even though Buffett made the process look effortless, the technique and discipline underlying it involved an enormous amount of work for him and his employees.

The decisions Buffett had made about stocks in the 1970s were defiant bets against pessimism in the great bear market, plagued by rampant unemployment and consumer prices that rose at an intolerable fifteen percent a year. Now that bet suddenly paid off, thanks to a desperate President Carter, who had appointed a new Federal Reserve Chairman, Paul Volcker, in 1979. Volcker ratcheted up the central bank discount rate to fourteen percent to get inflation under control. In 1981, new President Ronald Reagan began to cut taxes sharply, started deregulating business—and supported Volcker despite the howls of pain his policies were causing. In late 1982, the bull market of the 1980s began its stampede as the prices of stocks started catching up with the growth in corporate earnings.4

He was equally loath to lose Ben Rosner, who had finally retired from Associated Cotton Shops. Rosner’s underlings had made fun of his toilet-paper-pickin’ ways. Sure enough, as soon as they took charge, Associated fell into the tank. For months, Verne McKenzie slogged back and forth to New York’s garment district, peddling its soggy carcass.10 Finally, he found some buyer willing to pay half a million dollars to haul away the remains of a business that only recently had earned Berkshire as much as $2 million a year.

Between 1978 and the end of 1983, the Buffetts’ net worth had increased by a stunning amount, from $89 million to $680 million.

Buffett had said he gave his kids a few thousand dollars for Christmas each year and told them to expect half a million dollars when he died.26 That, he thought, was “enough money so that they would feel they could do anything, but not so much that they could do nothing.”

need you. But a great many, for the reasons mentioned

The gist of what he told his employees was something like: “You’re so good, this won’t take you any time at all, and it won’t cost anything to do. And, of course, you’ll have it back to me in the next mail. Because you’re just so damn great at what you do. It would take three people to replace you.”37

In keeping with his rising stature as a member of the CEO Club, he had just swapped the used Falcon for a fancy new Challenger jet that cost nearly $7 million. He revealed the airplane—which he had dubbed the Indefensible—in his shareholder letter, making sport of himself with St. Augustine’s prayer: “Help me, oh Lord, to become chaste—but not yet.” He would soon write his shareholders that he wanted to be buried in the jet.

If you were Sears in 1960, why couldn’t you keep getting the smartest employees and selling at the best prices? What was it you couldn’t see that prevented you from remaining the leader? Most of the proposed answers, regardless of the company, revolved around arrogance, complacency, and what Buffett called the “Institutional Imperative”—the tendency for companies to engage in activity for its own sake and to copy their peers instead of trying to stay ahead of them. Some companies didn’t bring in young people with fresh ideas. Sometimes managements weren’t attuned to tectonic shifts in their industry. Nobody suggested these problems were easy to cure. After a while Buffett asked everyone to pick their favorite stock. What about Kodak? asked Bill Ruane. He looked back at Gates to see what he would say. “Kodak is toast,” said Gates.8 Nobody else in the Buffett Group knew that digital technology would make film cameras toast. In 1991, even Kodak didn’t know that it was toast.9 “Bill probably thinks all the television networks are going to get killed,” said Larry Tisch, whose company, Loews Corp., owned a stake in the CBS network. “No, it’s not that simple,” said Gates. “The way networks create and expose shows is different than camera film, and nothing is going to come in and fundamentally change that. You’ll see some falloff as people move toward variety, but the networks own the content and they can repurpose it. The networks face an interesting challenge as we move the tran...

“I’ve had it so good in this world, you know. The odds were fifty-to-one against me being born in the United States in 1930. I won the lottery the day I emerged from the womb by being in the United States instead of in some other country where my chances would have been way different. “Imagine there are two identical twins in the womb, both equally bright and energetic. And the genie says to them, ‘One of you is going to be born in the United States, and one of you is going to be born in Bangladesh. And if you wind up in Bangladesh, you will pay no taxes. What percentage of your income would you bid to be the one that is born in the United States?’ It says something about the fact that society has something to do with your fate and not just your innate qualities. The people who say, ‘I did it all myself,’ and think of themselves as Horatio Alger—believe me, they’d bid more to be in the United States than in Bangladesh. That’s the Ovarian Lottery.”

“There could have been another Bill Gates among those men pulling our boat. They were born here, and they were destined to spend their lives tugging those boats the way they did ours. They didn’t have a chance. It was pure luck that we had a shot at the brass ring.”

But he would not consider buying a technology stock at any price. “When it comes to Microsoft and Intel,” he said, “I don’t know what that world will look like ten years from now. And I don’t want to play in a game where the other guy has an advantage.”5

Never in Buffett’s career had resolution and clear thinking been put to the kind of test that he had endured for the past three years. Every indication in the market said that he was wrong. He had only his inner conviction to steer him straight. And this was the needy man who was so sensitive to public criticism that he ran from anything that would expose him to it; who had sculpted his life around managing his reputation; and who fought like a tiger against anything that could sully it. Yet, even under siege to his reputation, this time, Buffett never fought back. He neither wrote editorials, nor dueled in the press, nor gave television interviews to defend himself. He and Munger carried on their regular dialogue with Berkshire’s shareholders, saying that while the market was overvalued, they could not predict how long it would last. Finally, not for the record but as a warning and a way of teaching, Buffett explained his views once and for all and predicted that the market would fall far short of investors’ hopes for two decades in a tour de force of a speech at Sun Valley that he shortly afterward turned into a Fortune article.

He’d warned that trees don’t grow to the sky; someday everything must end. Yet he himself couldn’t face the day he would have to draw the line under his career and say: “This is it. I’m done. The Sistine Chapel is finished. No further brushstroke will improve it—any further effort will produce an ordinary result.” He was sixty-nine years old. He couldn’t believe that he was sixty-nine years old; he still felt like a young man.

By eight o’clock it became clear that they needn’t have bothered to show up before dawn. Half the seats in the house were empty. Thirty minutes later, the auditorium held nine thousand people.12 Attendance was down by forty percent from the fifteen thousand who had come the year before.

Gaylord Hanson of Santa Barbara, California, stood at the microphone to harangue that he had bought BRK near its highs in 1998 because of Buffett’s track record and had come out okay only because the money he’d lost had been made up by four technology stocks.15 He urged Buffett to invest at least ten percent of Berkshire’s assets in technology, “the only game in town. Isn’t there enough left in your brain power to maybe pick a few?” It was worse than humiliating. Looking out into the audience, Buffett saw that, for the first time, some of them assumed that he was letting them down: the effort of nearly fifty years rolled backward, undone, his own shareholders turned against him. His age suddenly signified not experience but obsolescence. In the press, people now referred to him as an old man.

In the case of mobile homes, the banks lent money to the manufacturers, who used it to lend money to the buyers. Historically, this process had worked, because if the mobile-home maker made bad loans, it faced the discipline of not getting paid back. But then the mobile-home makers began to sell their loans, handing off the risk of not getting paid back. That was now somebody else’s problem. The “somebody else” who had assumed the problem was an investor. In a process known as “securitization,” for some years, Wall Street had neatly packaged loans like these and sold them to investors through a “collateralized debt obligation,” or CDO—debt backed by the mortgages. They combined thousands of mortgage loans from all over the U.S. and sliced them into strips called “tranches.” The top-tier tranches got first dibs on all the cash flow from a pool of mortgages. The next tranches had second dibs, and so forth down the line. These tranches paid a rating agency to assign the top AAA rating to the first-dibs tranches, AA ratings to the second-dibs tranches, and so on. The banks sold off the tranches to investors. As lending standards declined, the quality of the CDOs—even AAA CDOs—got sludgier.5 Yet, investing in AAA CDOs now appeared to contain no risk. “When money is free,” wrote Charles Morris later, “and lending is costless and riskless, the rational lender will keep on lending until there is no one left to lend to.”6

If it was pointed out that risk did not disappear, those who participated in the market would explain with a sigh that derivatives “spread” the risk to the far corners of the globe, where it would be absorbed by so many people that it could never hurt anyone. In his 2002 shareholder letter, Buffett called derivatives “toxic,” and said they were “time bombs.” At the shareholder meeting that year, Charlie Munger described the accounting incentives to exaggerate profits on derivatives, and concluded, “To say derivative accounting in America is a sewer is an insult to sewage.” In his 2003 letter, Buffett wrote of derivatives as “financial weapons of mass destruction.”7

“Basically, when you get to my age, you’ll really measure your success in life by how many of the people you want to have love you actually do love you. “I know people who have a lot of money, and they get testimonial dinners and they get hospital wings named after them. But the truth is that nobody in the world loves them. If you get to my age in life and nobody thinks well of you, I don’t care how big your bank account is, your life is a disaster. “That’s the ultimate test of how you have lived your life. The trouble with love is that you can’t buy it. You can buy sex. You can buy testimonial dinners. You can buy pamphlets that say how wonderful you are. But the only way to get love is to be lovable. It’s very irritating if you have a lot of money. You’d like to think you could write a check: I’ll buy a million dollars’ worth of love. But it doesn’t work that way. The more you give love away, the more you get.”12

“If you go from the first floor to the hundredth floor of a building and then go back to the ninety-eighth, you’ll feel worse than if you’ve just gone from the first to the second, you know. But you’ve got to fight that feeling, because you’re still on the ninety-eighth floor.”

picked up credentials, then passed through security, their