BookReview: The Snowball: Warren Buffett and the Business of Life
by Alice Schroeder, Bantam, 9/29/2008, 978-0553805093

Wow! I am not a big fan of biographies. I find they are self-aggrandizing. This tome kept me rivetted to the end. Alice Schroeder writes excellently, and Warren Buffet required that she choose "the less flattering" way to describe him and history.

The book makes Buffet real in a way that the press has failed to do. He's as frail a human as the poorest person on the planet. I personally related to his inability to deal with emotions as well as his desire to be liked by everyone. It's an affliction I've had to learn to get over, and it's clear from this book that Buffet has learned how to deal with it.

Although Schroeder is a business writer, the powerful content in this book is about Buffet's personal life. Who is Astrid? Why didn't he divorce Susie? Why is he stingy with his kids? Why does he love money so much? All these questions are answered and more.

As a Berkshire Hathaway investor, I am pleased to know that Buffet has similar business principles. My favorite quote of the book: "Find something you are passionate about. I only work with people I like. If you go to work every morning with your stomach churning, you're in the wrong business." This is my business philosophy summarized by Schroeder better than I could have ever done it. For this reason alone, the book was worth the read.

I don't love money like Buffet, which is why I entrust all my money to Berkshire. I am not passionate about investing above all else, and even when I have tried to invest with passion, I was not able to match his record so if you can't beat 'em, join 'em. Some people would say that it is foolish investing in one stock. Sure, when Buffet or Munger dies, we're in for a price shock but that doesn't change the underlying fundamentals of the myriad businesses which are Berkshire. They are still selling insurance, soft drinks, and furniture. Neither Buffet nor Munger runs these companies, they are run independently by competent managers, who aren't going to turn incompetent just because one or two of their investors dies. If anything, this book gave me even more confidence that Buffet and Munger have done a brilliant job, and I should stick with them.

However, don't take my advice. Read this book, and decide for yourself.

[k169] Most of the press people liked Buffett, who went out of his way not to be disliked by anyone. He also intrigued them.

[k188] Afraid of being disinvited to the conference, those who voiced any criticism rarely went beyond vague hints that Herbert was "unusual," restless, impatient, and possessed of an oversize personality. Standing in the shadow of his tall, wiry frame, one had to strain to keep up with the words that crackled forth like machine-gun fire. He barked questions, then cut off respondents mid-sentence, lest they waste a second of his time. He specialized in saying the unsayable. "Ultimately Wall Street will be eliminated," he once told a reporter, although he ran a Wall Street bank. He referred to his competitors as "hot-dog vendors."

[k198] Buffett's friend Tom Murphy referred to this kind of event as "elephant-bumping." "Anytime a bunch of big shots get together," says Buffett, "you can get people to come, because it reassures them if they're at an elephant-bumping that they're an elephant too."

[k218] As the parents and grandparents played, the sitters saw to it that each Joshua and Brittany was accompanied by his or her own playmate for whatever activity they chose--a tennis clinic, soccer, bicycling, kickball, a wagon ride, a horse show, ice-skating, relay races, rafting, fishing, an art project, or pizza and ice cream. Each babysitter was personally selected to ensure that every child always had such a wonderful time that they would beg to come back year after year--while at the same time delighting their parents with occasional glimpses of the very, very attractive young person who was allowing them to spend days of guilt-free time with other adults.

[k250] Thus freed to perform only for their peers, the speakers said important and often true things that could never be articulated in front of the press because they were too blunt, too nuanced, too alarming, too easily satirized, or too likely to be misinterpreted.

I always find it's hard to explain this many zeroes. This is an excellent description -- written by Rob after a nice gin martini. :-)

[k255] With a trillion dollars in 1999, you could pay the income tax of every single individual in the United States. You could give a brand-new Bentley automobile to every household in more than nine states. You could buy every single piece of real estate in Chicago, New York City, and Los Angeles--combined. Some of the companies making presentations needed that money, and they wanted this audience to give it to them.

Amazing to read in 2009, now that the DOW is 8,675.

[k266] As technology stocks overtook the "old economy," the Dow Jones Industrial Average*1 had burst through the once-distant 10,000-point barrier only four months before, doubling in less than three and a half years.

[k273] They felt they had been invited to Sun Valley because they were the people of the moment, and they had trouble believing that Leibovitz had made her own choices about who to photograph. Why, for example, would she include Buffett? His role in media had come mostly secondhand--through board memberships, a large network of personal influence, and a history of media investments large and small. Besides, he was old media. They found it hard to believe that his face in a photograph still sold magazines.

[k286] The stock of his company, Berkshire Hathaway, languished in their dust, and his rigid rule of not buying technology stocks seemed outmoded. But the criticism had no influence on how he invested, and to date, the only statement he had made in public was that he never made market predictions.

[k313] "I rang that doorbell. I knocked. Nothing happened. But Don and Mickie were upstairs, and it was pitch-black. "Too dark to read, and too early to go to sleep. And I remember that day as if it were yesterday. That was June twenty-first, 1962. "Clarke, when were you born?" "March twenty-first, 1963." "It's little things like that that history turns on. So you should be glad they didn't give me the ten thousand dollars."

[k324] "I will be talking about pricing stocks, but I will not be talking about predicting their course of action next month or next year. Valuing is not the same as predicting. "In the short run, the market is a voting machine. In the long run, it's a weighing machine. "Weight counts eventually. But votes count in the short term. And it's a very undemocratic way of voting. Unfortunately, they have no literacy tests in terms of voting qualifications, as you've all learned." screen to his right. Bill Gates, sitting in the audience, caught his breath for a second, until the notoriously fumble-fingered Buffett managed to get the first slide up. DOW JONES INDUSTRIAL AVERAGE December 31, 1964 874.12 December 31, 1981 875.

[k337] He backed up a step or two. "What you're doing when you invest is deferring consumption and laying money out now to get more money back at a later time. And there are really only two questions. One is how much you're going to get back, and the other is when. doesn't say when." Interest rates--the cost of borrowing--Buffett explained, are the price of "when." They are to finance as gravity is to physics. As interest rates vary, the value of all financial assets--houses, stocks, bonds--changes, as if the price of birds had fluctuated. "And that's why sometimes a bird in the hand is better than two birds in the bush and sometimes two in the bush are better than one in the hand."

[k348] Their attitude was that Buffett had no right to call them greedy. Warren--who'd hoarded his money for years and given very little away, who was so cheap his license plate said "Thrifty," who spent most of his time thinking about how to make money, who had blown the technology boom and missed the boat--was spitting in their champagne.

[k367] U.S. HORSE POPULATION 1900--17 million 1998--5 million "Frankly, I'm kind of disappointed that the Buffett family was not shorting horses throughout this entire period. There are always losers."

[k377] "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. "So I submit to you: I really like to think that if I had been down there at Kitty Hawk, I would have been farsighted enough and public-spirited enough to have shot Orville down. I owed it to future capitalists."

Buffet predicted a black swan but not when we'd see it.

[k448] By the time fireworks exploded across the sky at evening's end, Sun Valley ' had been declared another glorious five-day extravaganza. Yet what most people would remember was not the rafting or the skaters; it was Buffett's talk about the stock market--the first forecast he had made in exactly thirty years.

[k582] To Buffett, the stock price represented an uncomplicated measure of his success. It had grown in an ascending line since the day he first bought BRK for $7.50 a share. Even though the market had rocked through the late 1990s, until 1999 an investor who bought BRK and held on to it would have been better off.

[k606] How much for a small, new business that was losing money? FIXME2022 Toys "R" Us was earning $400 million a year and had sales of $11 billion. FIXME2022 eToys was losing $123 million a year and had sales of $100 million. The market's voting machine said that eToys was worth $4.9 billion, and Toys "R" Us was worth about a billion less than that. The presumption was that eToys was going to crush Toys "R" Us through the Internet.

[k946] He loved to play cop, and he liked almost anything that brought him attention, including dressing up and playing at different roles.

[k958] Bertie, on the other hand, was the self-confident, adventurous one, which Doris and Warren thought might explain why Leila rarely tore into her. Bertie had her own theory, seeing herself as someone who was able to keep up appearances in the way that their mother valued. What mattered most to Leila was the esteem of others; she had what Warren would later come to call an Outer Scorecard. She was always worrying about what the neighbors would think, nagging her daughters to create the right appearance. "I was so careful to do the right things. I didn't want it to happen to me," Bertie says of Leila's tirades.

[k2531] On that basis, it was cheap. He wrote a report about it for his father's stockbrokerage firm, saying that GEICO was trading at $42 per share, a multiple of about eight times its recent earnings per share. Other insurance companies, he noted, were selling at much higher multiples of their earnings. Yet GEICO was a small company in a large field, whereas its competitors were companies "whose growth possibilities have largely been exhausted." Warren then made a conservative projection of the company's value in five years. He thought the stock would be worth between $80 and $90 per share.

[k2629] Over the twenty-year life of Graham-Newman Corporation, its performance had beaten the stock market's performance by an average of 2.5 percent a year--a record exceeded by only a handful of people in the history of Wall Street. That percent might sound trifling, but compounded for two decades, it meant that an investor in Graham-Newman wound up with almost sixty-five percent more in his pocket than someone who earned the market's average result.

[k2749] Graham turned him down. "He was terrific. He just said, 'Lookit, Warren. In Wall Street still, the "white-shoe" firms, the big investment banks, they don't hire Jews. We only have the ability to hire a very few people here. And, therefore, we only hire Jews.' That was true of the two gals in the office and everybody. It was sort of like his version of affirmative action. And the truth is, there was a lot of prejudice against Jews in the fifties. I understood."

[k3251] Susie recognized Warren's vulnerability, how much he needed to be soothed and comforted and reassured. More and more, she could see the effect his mother had had on her children. Doris was the more badly damaged, but Leila had convinced both Warren and Doris that deep down they were worthless. In every area of life except business, Susie was discovering, her husband was riddled with self-doubt. He had never felt loved, and she saw that he did not feel lovable.

[k3792] Warren, who desperately wanted to be but had never felt "normal," assuaged his anxiety with statistics, reasoning that the mysterious disorder seemed to affect only the family's women. He never dwelled on the unpleasant. He would later come to think of his memory as functioning like a bathtub. The tub filled with ideas and experiences and matters that interested him. When he had no more use for information, whoosh--the plug popped up, and the memory drained away. If new information about a subject appeared, it would replace the old version. If he didn't want to think about something at all, down the drain it went. Certain events, facts, memories, and even people appeared to vanish. Painful memories were the first to be flushed. The water went somewhere, and along with it might go context, nuance, and perspective, but what mattered was that it was gone. The bathtub memory's efficiency freed up enormous amounts of space for the new and the productive. At times, however, disturbing thoughts did bubble up from somewhere, as when he expressed concern for other people: for example, several friends who cared for mentally ill wives.

[k3803] In August, he went back to New York to attend the final shareholders' meeting of the Graham-Newman Corporation. Everyone important on Wall Street seemed to be present at Graham-Newman's wake. Investor Lou Green, his head wreathed in clouds of foul-smelling smoke from an enormous stogie, towered over them from his six-foot-four height. He accused Graham of making a big mistake. Why had Graham and Newman not developed talent? he asked. "They'd been working here for thirty years building up this business," he declared to everyone standing nearby. "And all they would have had to run it was this kid named Warren Buffett. He's the best they could come up with. And who'd want to ride with him?"

As I read this I'm struck with the parallels to my own career and life: mental illness, obsession with detail, drive to be the best, need for acceptance, intense focus to the exclusion of all else, flushing the past, inability to groom recruits... Yet the conclusion I come to is not to be tight-fisted as Buffet is and was. I tend toward the Richard Stallman philosophy of openess.

[k3820] With the formation of the B-C partnership on October 1, 1956, Warren was now managing more than half a million dollars, including his own money, which was not in any of the partnerships. He operated out of a tiny study at home that could be entered only by passing through the bedroom. He worked odd hours, a night owl like Susie, reading annual reports in his pajamas, drinking Pepsi-Cola and eating Kitty Clover potato chips, enjoying the freedom and solitude. He pored over the Moody's Manuals looking for ideas, absorbing statistics on company after company. During the day, he went to the library and read newspapers and industry trade magazines. As with his boyhood paper route, he took care to handle everything of value personally, a pleasure in and of itself. He typed his own letters on an IBM typewriter, carefully lining up his letterhead sheet on the carriage. To make copies he slid sheets of blue carbon paper and tissue-thin onionskin behind the first page. He did all his own filing. He did the bookkeeping himself and prepared his own tax returns. With its numbers, accuracy, and the measuring of results, the recordkeeping aspect of the job pleased him.

[k4382] Shining with the reflected glow of a delayed childhood, burnished with the patina of Omaha's railroading history, the train was Warren's totem. His children were forbidden to go near it. By now, his relentless obsession with money and obliviousness to his family were a running joke among his friends. "Warren, those are your children--you recognize them, don't you?" people said. When he was not traveling, he could be found wandering through the house, nose buried in an annual report. The family swirled around him and his holy pursuit--the disengaged, silent presence, feet up in his stringy bathrobe,

[k4529] He wasn't uncaring, and he was often available. But in conversation his words often had a subtly prepared, even rehearsed quality. He was always one step ahead. Whatever went on inside his mind took place between the lines; it came through in the silences, the flashes of wit, the tremulous flight from certain topics of conversation. His feelings danced behind so many veils that even he seemed unaware of them most of the time.

[k4601] At their new firm, Munger and Hills imposed an elitist, Darwinian ethos designed to attract the brightest and most ambitious. The partners all voted on one another's pay, which was circulated for everyone to know. Even as the firm launched,

[k4872] As his record of outstanding results lengthened, his letters also began to display a preoccupation with measuring success and failure. He used terms like "guilt," "embarrass," "disappoint," or "blame" with unusual frequency, including to describe his so-called mistakes--for he remained obsessed with never letting anyone down. As readers began to recognize this pattern, some assumed he was manipulating them, while others accused him of false modesty. Hardly anybody knew how deep his sense of insecurity ran.

[k5253] Warren had strong views about specialization; he defined his special skills as thinking and making money. When asked to donate, his first choice, always, was to donate ideas, including ideas that would get other people to give money. But he would also give money himself--not a lot, but some--to politicians and to Susie's causes. He never labored in the trenches stuffing envelopes; volunteering directly for causes, no matter how urgent and important, would consume time he felt was more efficiently spent thinking of ideas and making more money to write bigger checks.

[k5456] Buffett knew that he wanted to be in business with the kind of guy who would leave a black-tie party to count sheets of toilet paper; a guy who might screw the guy across the table but never his own partner. He made a deal with Rosner for $6 million. To make sure that Rosner would stay on the job after he bought the business, he flattered Rosner, made certain he got the numbers to evaluate its performance, and otherwise left him alone. Buffett felt at one with the Ben Rosners of the world--he saw in their relentlessness the spirit of success. He was sick of problem companies like Hochschild-Kohn and was looking for more Ben Rosners, people who had built excellent businesses that he could buy. He and Rosner shared a mutual obsession. As Buffett liked to put it, "Intensity is the price of excellence."

[k5862] After having described the travails of textiles eloquently in 1967, he made no further mention of the business in 1968, although the prospects and results of the Berkshire mills had not improved. Earnings at DRC were falling because of Hochschild-Kohn. Still, Buffett did not take the logical next step, which would have been to sell Berkshire Hathaway and Hochschild-Kohn. Here, his commercial instincts chafed against some of his other traits: the urge to collect, the need to be liked, the preoccupation with avoiding confrontation after the Dempster windmill war. In an intricate minuet of rationalization, he explained his thinking in his January 1968 letter to the partners: "When I am dealing with people I like in businesses I find stimulating (what business isn't?), and achieving worthwhile overall returns on capital employed (say, ten to twelve percent), it seems foolish to rush from situation to situation to earn a few more percentage points. It also does not seem sensible to me to trade known pleasant personal relationships with high-grade people, at a decent rate of return, for possible irritation, aggravation, or worse at potentially higher returns."

[k5961] And as much as Buffett admired Noyce, he did not buy Intel for the partnership, thus passing on one of the greatest investing opportunities of his life. While he had lowered his investing standards in difficult environments--and would do so again--one compromise he would never make was to give up his margin of safety. This particular quality--to pass up possible riches if he couldn't limit his risk--was what made him Warren Buffett.

[k6229] Even as Buffett and Munger were working on the sale of Hochschild-Kohn in the fall of 1969, Forbes hit the newsstand with a story about Buffett titled "How Omaha Beats Wall Street." The article opened in such an arresting manner that other writers covering Buffett would copy it for decades afterward. "$10,000 invested in his Buffett Partnership in 1957," Forbes said, "is now worth $260,000." The partnership, which now had assets of $100 million, had grown at an annual compounded rate of thirty-one percent. Over that twelve-year period, "it hasn't had one year in which it lost money.... Buffett has accomplished this through following consistently fundamental investing principles." The anonymous columnist for Forbes then wrote one of the more insightful statements ever made about Buffett: "Buffett is not a simple person, but he has simple tastes."

[k6252] Those who spent long periods in his presence, however, found the unleashed whirlwind of his energy exhausting. "Insatiable," they whispered, and sometimes felt a guilty relief when his attention lapsed. He inhaled information and was prone to deluging his friends with mountains of clippings and reading material that he thought would interest them, before realizing with a start that they had fallen months behind his pace. His conversations were less casual than they seemed. They always seemed to have a purpose, however obscure it might be to those on the receiving end. People sometimes realized he was somehow testing them. Buffett vibrated with an inner tension that belied his outwardly casual style.

[k6711] And that was indeed the irony. It was Boys Town's background of Depression-era poverty that had probably led Wegner to accumulate money as if the "wolf was at the door," as Randy Brown put it. This same background had very likely lulled the board into overseeing Wegner's activities without questioning whether they made sense. But Warren Buffett, a product of the very same environment, who had the very same impulses, was going to bust them for it. The crime, in his eyes, was not just accumulating the money. It was piling it up mindlessly without a plan to use it. Boys Town didn't even have a budget. The sin to Buffett was an abdication of fiduciary responsibility, the failure to manage money responsibly on others' behalf.

[k7224] Munger now followed up by buying twenty percent of a near-defunct investment firm, Source Capital, for Blue Chip. "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.'"

The way financial people make deals has always amazed me. In the end it comes down to a gut feeling and a lot of testosterone. The more I read about Buffet, the more it seems that he succeeded by hustling and by the time of the GEICO bailout he was winning by using his reputation. At the same time, he's a survivor, and the companies he picks are also survivors. In business, that's the best you can hope for, I think.

[k8135] "The insurance industry can't afford to let these guys go down," Frinquelli told Gutfreund. "It would be a terrible black eye on the industry, and these assholes will not tolerate that." But when Byrne and Butler arrived at Salomon's offices for his last-ditch attempt to raise the money, Gutfreund opened with a bruising remark: "I don't know who'd ever buy that fucking reinsurance treaty you're trying to sell." "You don't know any fucking thing you're talking about," said Byrne right back. Displays of testosterone out of the way, Byrne made a passionate speech, citing "God and the national interest" among reasons why Salomon should raise the money, and referring to Buffett's investment. As Byrne waxed about GEICO's prospects and approached liftoff, Gutfreund fiddled with a long, expensive cigar. Finally, wrung out and crestfallen, Byrne ground to a halt. Then Butler said his piece. Byrne thought, from Gutfreund's demeanor, that they had failed. Then Gutfreund pointed at Byrne and said to Butler, "I will do this underwriting. I feel you've got the right guy, but you've got to keep him quiet."

[k8149] Buffett, the ace in the hole, was unperturbed by these events. When the offering looked as if it was not going to go off, he simply went to New York and met with Gutfreund, saying he stood ready to buy the whole deal--at a price.

[k8156] Indeed, once the self-fulfilling prophecy of the sage of Omaha took hold, there was more demand for the stock than shares to be had. Buffett got only a quarter of the deal. Within a few weeks, after a total of twenty-seven reinsurers came forward to provide the required reinsurance, the common stock had quadrupled and was trading around $8 a share. And GEICO's savior,

[k8204] Susie's friends would say that she created a separate life for herself within her marriage as a way to accommodate Warren's obsessions. As one put it, Warren's "real marriage was to Berkshire Hathaway." There was no getting around that fact.

[k8319] Paying with stock showed a sort of contempt for your own business versus whatever it was that you were buying--that is, unless you were paying with stock that had gotten wildly overpriced.

After Susie left him...

[k8577] The pieces of Buffett's life began to come back together into some sort of coherent whole. But he had been shocked into realizing the truth of Susie's insistence that sitting in a room making money was no way to spend a life; he began to see what he had missed. While he was friendly enough with his kids, he hadn't really gotten to know them. The reality behind the jokes ("Who is that? That's your son") meant that he would spend the next few decades trying to repair these relationships. Much of the damage could not be undone. At age forty-seven, he was just beginning to take stock of his losses.

To me this is one of the greatest attributes of Berkshire: Buffet's highly-effective, tight team.

[k8898] Buffett's hunt for things to buy had become more ambitious, free of the cigar butts and lawsuits of the decades before. The great engine of compounding worked as a servant on his behalf, at exponential speed and under the gathering approval of a public gaze. 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 few could execute them. Even though Buffett made the process look effortless, the technique and discipline underlying it actually did involve an enormous amount of work for him and his employees. As his business empire had expanded from coast to coast, from the shores of Lake Erie to the suburbs of Los Angeles, Kiewit Plaza remained at the center--a quiet but endlessly busy temple of commerce, furnished with dinged, scuffed steel-frame furniture and linoleum floors. With every new investment, there was more to do; but the number of people at headquarters barely changed. Buffett still remained behind closed doors, guarded by Gladys. The very rich Bill McKenzie managed the finances. The employees rarely left their tiny offices except for the occasional conclave in the conference room, which seated only four people. No chats took place around the watercooler. As for a period of ease following the scuffle at the Buffalo Evening News, McKenzie put it this way: "There was never such a time." Those who tested Rickershauser's Law of Thermodynamics found that the sun was indeed nice and warm, but Buffett was so focused and his mind worked at such speed that extended conversations with him left them sunburned. "My mind was so tired," said one friend. "I had to recuperate from seeing him," said another. "

[k8919] The managers out in the hinterlands who ran the businesses that Berkshire and Blue Chip owned were lucky because Buffett largely left them alone, his trick of management being to find obsessed perfectionists like himself who worked incessantly; then ignore them except for a "Carnegizing"--attention, admiration, and Dale Carnegie's other techniques--every now and then. Most would not have had it any other way.

[k9472] "Through no fault of their own, they were in a position of being a horse when the tractor arrived. The free market did them in. If you're fifty-five and you speak Portuguese, and you've been working on a loom for thirty years and your hearing is shot, you've had it. And there wasn't any answer. When you talk about retraining people--it's not like they'll all go become computer technicians by taking junior-college courses or something like that. "But you've also got to deal with the people that are displaced. The free market does all kinds of good things in this country, but we need a safety net. Society is getting the benefits, and it should pick up the tab." Warren, of course, was not going to pick up the tab because society lacked a proper safety net.

Buffet's businesses floundered in the 1970s and early 1980s. He didn't beat the DOW. He never lost faith in his model, and that is a core strength. I can relate to his ideals.

[k9548] By 1985 the unique business model that Buffett had designed began rising to its potential. No other business resembled it, and this structure would enable the dramatic compounding effect that propelled the shareholders' wealth.

[k9573] The 1980s would be an era of deals, deals, deals--most financed with debt, debt, debt. The Dow hadn't budged in seventeen years.

[k9582] "We were taking earnings or value that should've gone to the shareholders and bringing it unto ourselves," said Jerome Kohlberg, one of the first buyout financiers. "Corporate America was responsible for a lot of this. You have to ask the question, Why didn't they do it [cost-cutting] themselves?"

[k9813] Buffett spoke in metaphors the audience understood, using the emperor's new clothes and the bird in the hand versus the two in the bush. He told plain-spoken truths that other businessmen would not acknowledge, and routinely burst the bubble of corporate double-speak.

[k9821] Buffett's anomalous success, and the fame it had brought him, was putting him on the road to becoming a brand just as surely as Skippy peanut butter. Inevitably, therefore, he became the target of a group of finance professors who were at that very moment attempting to prove that someone like Buffett was a mere accident who should not be paid attention, much less worshipped. These academics had started by positing the reasonable but not necessarily obvious truth that if a whole lot of people were trying to be better than average, they would become the average. Paul Samuelson, an MIT economist, revived and circulated the 1900 work of Louis Bachelier, who observed that the market is made up of speculators who cohere into a whole that operates according to a "random walk." A professor from the University of Chicago, Eugene Fama, took Bachelier's work and tested it empirically in the modern-day market, which he described as "efficient." The scrabbling efforts of legions of investors to beat the market made those very efforts futile, he said. Yet an army of professionals had sprung up who charged everything from modest fees to the soon-to-be-legendary hedge-fund cut of "two-and-twenty"(two percent of assets and twenty percent of returns) for the privilege of managing an investor's money and trying to predict the future behavior of stocks. Stockbrokers raked their cut from all the individuals who were encouraged by TV shows and magazines to pick the next hot stock and compete with the pros. Every year, the sum of all these people's labors added up to exactly what the market did (less the fees). Charles Ellis, a consultant to professional money managers, blew the whistle on the market's pickpockets in 1975 in "Winning the Loser's Game," an article that showed that professional money managers failed to beat the market ninety percent of the time. Ellis's work also had disheartening implications for individual investors and the readers of books and attendees of seminars like "Invest Your Way to Millions." He said the best way to make money in the market was to simply buy an index of the market itself without paying the high fees that the toll-takers charged. Over the long term, the market tended to outperform bonds, so investors would receive the payback from the entire economy's growth. So far, so good. to make money in the market was to simply buy an index of the market itself without paying the high fees that the toll-takers charged. Over the long term, the market tended to outperform bonds, so investors would receive the payback from the entire economy's growth. So far, so good. The professors who had discovered this efficient-market hypothesis (EMH) kept hacking away at their computers over the years, however, to turn these ideas into an even tighter version, one that had the purity and rigor of physics and mathematics, one to which there could be no exceptions. They concluded that nobody could beat the average, that the market was so efficient that the price of a stock at any time must reflect every piece of public information about a company. Thus, studying balance sheets, listening to scuttlebutt, digging in libraries, reading newspapers, studying a company's competitors--all of it was futile. The price of a stock at any time was "right." Anybody who beat the average was just lucky--or trading on inside information.

In software, diversification happens naturally as a direct product of copy-and-paste. Sofware improves when it is concentrated (refactored), not diversified. The fact that Buffet revoked the classical approach to diversification is fascinating. Money and software are more alike than I had previously thought.

[k9860] Columbia held a seminar in 1984 to celebrate the fiftieth anniversary of Security Analysis. Buffett was by then so identified as Ben Graham's intellectual heir that Graham himself had asked him to revise and update The Intelligent Investor. The two were not able to agree on certain things--principally Buffett's belief in concentration versus Graham's devotion to diversification--and in the end Buffett wrote only the introduction. Nevertheless,

[k9883] The one great service EMH would have performed, if anybody listened, was to discourage the average person from believing they could outwit the market. Nobody except the toll-takers could object to that. But the tendencies of humankind being what they are, EMH became de rigueur in business school classrooms, yet the number of individual investors and professional money managers who assumed that they were smarter than average only grew, the toll-takers kept taking their cut, and the market went on as before. Thus the main effect of "

[k9898] To them, risk was "inextricably bound up in your time horizon for holding an asset." Someone who could hold an asset for years could afford to ignore its volatility. Someone who was leveraged did not have that luxury--leverage costs; moreover the lender's (not the borrower's) time horizon defines the length of the loan. Thus a risk of leverage is that it takes away choices. The investor may not be able to wait out a volatile market; she is burdened by the "carry" (that is, the cost) and she depends on the lender's goodwill. But betting on volatility seemed to make sense when the market rose as predicted. When enough time passes and nothing bad happens, people who are making a lot of money tend to think it is because they are smart, not because they are taking a lot of risk.

[k9970] But Buffett was growing Berkshire's book value far faster than his shareholders could have accumulated such wealth themselves, and he had the scorecard to prove it. Moreover, it was a long-term scorecard, far more comfortable for him than the year-to-year pressure of beating the market's bogey. By shutting down the partnership, he had freed himself from that tyranny; in fact he no longer presented numbers in a fashion that allowed someone to calculate his investing performance from inception. Besides,

[k10668] Salomon had the United States' second-largest balance sheet--larger than Merrill Lynch, Bank of America, or American Express. Nearly all of its loans consisted of short-term debt that was callable by lenders in days or at most weeks. Only $4 billion of equity supported $146 billion of debt. Dangling off the side of the balance sheet on any given day were tens more billions, perhaps as many as $50 billion a day, of uncleared trades--transactions executed, but not yet settled. These would stall midair. Salomon also had many hundreds of billions of derivative obligations not recorded anywhere on its balance sheet--interest-rate swaps, foreign-exchange swaps, futures contracts--a massive and intricate daisy chain of obligations with counterparties all over the world, many of whom in turn had other interrelated contracts outstanding, all part of a vast entangled global financial web. If the funding disappeared, Salomon's assets had to be sold--but while the funding could disappear in a few days, the assets would take time to liquidate. The government had no national policy to provide loans to teetering investment banks because they were "too big to fail." The firm could melt into a puddle overnight.

[k11369] The Congressmen excoriated Salomon, postured as saviors of investors, and demanded a total break with the past. Nonetheless, they appeared slightly awed by Buffett. When he spoke, "The Red Sea parted, and the Oracle appeared," says Maughan. Buffett laid the problems on Wall Street. "Huge markets attract people who measure themselves by money," he said. "If someone goes through life and measures themselves solely by how much they have, or how much money they earned last year, sooner or later they're going to end up in trouble." Salomon, he said, was going to have different priorities from now on. "Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless."

[k11486] "I said that we would have people to match our principles, rather than the reverse. But I found out that wasn't so easy."

[k11681] "I was at my best at giving financial advice when I was twenty-one years old and people weren't listening to me. I could have gotten up there and said the most brilliant things and not very much attention would have been paid to me. And now I can say the dumbest things in the world and a fair number of people will think there's some great hidden meaning to it or something."

[k11758] "Bill started trying to convince me to get a computer. I said, I don't know what it's going to do for me. I don't care how my stock portfolio is doing every five minutes. And I can do my income taxes in my head. Gates said he would pick out the best-looking gal at Microsoft and send her to teach me how to use the computer. He would make it totally painless and pleasant. I told him, 'You've made me an offer I almost can't refuse, but I will refuse it.'" "Then at dinner, Bill Gates Sr. posed the question to the table: What factor did people feel was the most important in getting to where they'd gotten in life? And I said, 'Focus.' And Bill said the same thing." It is unclear how many people at the table understood "focus" as Buffett lived that word. This kind of innate focus couldn't be emulated. It meant the intensity that is the price of excellence.

[k11767] perfectionism that made Thomas Edison the quintessential American inventor, Walt Disney the king of family entertainment, and James Brown the Godfather of Soul.

[k11795] The conversation continued. 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. Nobody else in the Buffett Group knew that the Internet and digital technology would make film cameras toast. In 1991, even Kodak didn't know that it was toast.

[k11978] was so gentle that she could correct him without hitting the hair-trigger button in him that reacted to criticism--Buffett always avoided or limited his time with anyone he feared might criticize him.

[k12460] Long-Term owed money to a subsidiary of Berkshire. It owed money to people who owed money to Berkshire. It owed money to people who owed money to people who owed money to Berkshire. "Derivatives are like sex," Buffett said. "It's not who we're sleeping with, it's who they're sleeping with that's the problem."

[k12899] People thought, from the way he disciplined every syllable that exited his mouth, that he was above the criticism. "Never," he said, when asked if it bothered him when people called him a has-been. "Nothing bothers me like that. You can't do well in investing unless you think independently. And the truth is, you are neither right nor wrong because people agree with you. You're right because your facts and reasoning are right. In the end, that's what counts." But these were separate issues. While he had no problem thinking independently, he was indeed miserable over being called a has-been. Asked around then if being in the public eye for decades helped keep the criticism in perspective, Buffett paused for a long while. "No. It never gets easier," he said soberly. "It always hurts just as much as the first time." But he could not do a thing about it.

[k13382] Then he seemed to catch his rhythm. "People ask me where they should go to work, and I always tell them to go to work for whom they admire the most," he said. He urged them not to waste their time and their life. "It's crazy to take little in-between jobs just because they look good on your résumé. That's like saving sex for your old age. Do what you love and work for whom you admire the most, and you've given yourself the best chance in life you can."

[k13667] "Wealth is just a bunch of claim checks on the activities of others in the future. You can use that wealth in any way you want to. You can cash it in or give it away. But the idea of passing wealth from generation to generation so that hundreds of your descendants can command the resources of other people simply because they came from the right womb flies in the face of a meritocratic society. "I'd have a higher tax at the higher levels of wealth. I wouldn't mind having no tax up to a point and then a hundred percent tax for an estate over a hundred and fifty million dollars. "The most important thing is to ask, 'And then what?' If you eliminate the twenty billion dollars or so raised by the estate tax, you've got to make the money up by taxing everybody else somehow. It's amazing how hard the American population will fight for the families of those few thousand people who pay large estate taxes and for the whole rest of the country to pay for it out of their own pockets.

[k13858] In his 2002 shareholder letter, Buffett called derivatives "toxic," and said they were "time bombs" that were expanding unchecked and could cause a chain reaction of financial disaster. 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." So many of these deals existed, he wrote, that they had formed a daisy chain around the globe.

[k13876] It was going to take billions of profits before General Re groveled its way back into Buffett's good graces. Its derivatives business would have little to do with that, either way. The same was not true for the global economy. By a "low but not insignificant probability," Buffett said, sooner or later--he didn't know when--"derivatives could lead to a major problem." Munger was more blunt. "I'll be amazed," he said, "if we don't have some kind of significant blowup in the next five to ten years."

[k14482] Four melodies in fifteen minutes.'...I love music. But actually U2's music doesn't blow me away. What interests me is that Bono splits the revenue of U2 among four people absolutely equally."

[k14517] Buffett did not believe in perpetual foundations that entrusted money to the whims of future generations of trustees. But with only a couple of employees, the Buffett Foundation was woefully ill-equipped to ramp up fast enough to give away a billion dollars a year.

[k14569] Munger's favorite construct was to invoke Carl Jacobi: "Invert, always invert." Turn a situation or problem upside down. Look at it backward. What's in it for the other guy? What happens if all our plans go wrong? Where don't we want to go,

[k14624] Be long-term greedy, not short-term greedy.

[k15582] "No. Stocks are the things to own over time. Productivity will increase and stocks will increase with it. There are only a few things you can do wrong. One is to buy or sell at the wrong time. Paying high fees is the other way to get killed. The best way to avoid both of these is to buy a low-cost index fund, and buy it over time. Be greedy when others are fearful, and fearful when others are greedy, but don't think you can outsmart the market. "If a cross-section of American industry is going to do well over time, then why try to pick the little beauties and think you can do better? Very few people should be active investors."

[k15609] "The purpose of life is to be loved by as many people as possible among those you want to have love you." about money.) How do I know what is right? Follow your Inner Scorecard. What should I do about a career? Find something you are passionate about. I only work with people I like. If you go to work every morning with your stomach churning, you're in the wrong business.

[k15645] Warren Buffett was a man who loved money, a man for whom the game of collecting it ran in his veins as his lifeblood. That love kept him going: buying little stocks like National American, selling GEICO to have the money to buy something cheaper, pushing at the boards of companies like Sanborn Map to do the right thing for shareholders.

[k15653] Warren Buffett was a timid man who shied from confrontation and needed people to cushion him from life's rougher edges. His fears were personal, not financial; he was never timid when it came to money. His passionate yearning to be rich gave him the courage to ride his bicycle past the house with the awful dog and throw those last few newspapers in Spring Valley. It sent him to Columbia, seeking Ben Graham, after Harvard turned him down. It made him put one foot in front of the other, calling on people as a prescriptionist, while they rejected him over and over. It gave him the strength to return to Dale Carnegie after losing his courage the first time. It forced him through the decisions in the Salomon crisis to make his great withdrawal from the Bank of Reputation. It lent him the dignity to face years of almost intolerable criticism without counterattacking during the Internet bubble. He had spent his life contemplating, limiting, and avoiding risk, but in the end he was braver than he realized himself.

[k15667] "In the end," says Munger, "he didn't want to do it. He was competitive, but he was never just rawly competitive with no ethics. He wanted to live life a certain way, and it gave him a public record and a public platform. And I would argue that Warren's life has worked out better this way."

[k15681] "The snowball just happens if you're in the right kind of snow, and that's what happened with me. I don't just mean compounding money either. It's in terms of understanding the world and what kind of friends you accumulate. You get to select over time, and you've got to be the kind of person that the snow wants to attach itself to. You've got to be your own wet snow, in effect. You'd better be picking up snow as you go along, because you're not going to be getting back up to the top of the hill again. That's the way life works."

[k15693] Trees don't grow to the sky, he always said; as Berkshire's capital grew, the climb would get steeper. But investors in Berkshire had only gratitude for the "lower" returns. Those who bought an index of the market had just suffered through what the Wall Street Journal called a "lost decade" in which the S&P 500 index had gone exactly nowhere, falling below its level of April 1999.2 Buffett's talk at Sun Valley was unfolding along the lines he had discussed; the period after the 1999 stock market bubble had burst was now the third-longest stretch in the past hundred years when the market made no progress.

[k15776] General Re, Berkshire's other problem-child investment, had benefited from favorable insurance markets after September 11. It reported the most profitable results in its history in 2007, with $2.2 billion of pretax operating earnings. By then Gen Re had earned back the losses and restored its balance sheet to a better condition than when Buffett bought it.

Via Rob 01/08/2009