"'So,' I said. 'Well. If you've had a little too much to drink, and you punch three extra zeroes in there by mistake, is the firm committed? Does it have to follow through with the trade?'

"And he said, 'Yeah.'

"So I had these nightmares of this guy, at three in the morning, maybe with a girl still in the bed or something, going over there in a daze and sort of punching something into the computer in the middle of the night and then staggering back to bed. And finding out the next morning that instead of a trillion yen, he'd put in a quadrillion yen."

To Buffett, it was obvious that the combination of fallible human beings and judgment-free computers in a completely unmonitored, unsupervised environment, meant an almost unlimited potential for things to go wildly out of control. But as a board member, he lacked authority to make changes and could only try persuasion. By now he and Munger had wrangled repeatedly-and unsuccessfully-with Salomon's management. Munger had taken over the audit committee-which had not formerly been a bastion of zealous oversight-and put it through six-and seven-hour dissections of the firm and its accountants. Munger discovered that Salomon's derivatives business had grown immensely, using trades for which no ready market existed. The trades would not settle for long periods, sometimes years. With minimal cash changing hands, the derivatives were valued on Salomon's books using a model.38 Since the model was created by those whose bonuses it would determine, not surprisingly the models usually showed the trades were quite profitable. As much as $20 million of profits had been overstated through such accounting mismarks.39 The audit committee, however, addressed only trades and deals already approved, and usually completed. The real oversight took place before the fact.

There, in the one area in which Buffett and Munger unequivocally had more skill than anyone else-making investments-they weighed in loudest of all-and were ignored. Their protestations only alienated them from the employees. In one example, Salomon's Phibro unit had formed a joint venture with a seven-year-old Houston company, Anglo-Suisse, to build oil fields in West Siberia, south of the Arctic Circle, that would supposedly revolutionize oil production in Russia. The White Nights venture brought peace offerings to Russia, among them a recreation center, food, and clothing, all flown over from the United States.

"Anglo-Suisse," Munger said when the idea was floated. "This is an idiotic idea. There are no Anglos and no Swiss involved in this company. The name alone is reason not to get involved."

But Salomon put $116 million into the joint venture anyway, thinking that oil was going to be integral to Russia's future and that Western capital was needed to extract the oil. But, while "the country isn't going to go away," as Buffett said, and "the oil isn't going to go away," the Russian political system could go away. No margin of safety could cover that.40 Sure enough, as soon as the White Nights joint venture got going, the Russian government began toying with a tax on oil exports. The tax nearly wiped out White Nights's profit. Then the volume of oil production proved disappointing. Russian nabobs flew to the United States and expected to be entertained with prostitutes. The Russian government was unpredictable and uncooperative, resulting in setbacks from start to finish. Somebody was going to make a lot of money from oil in Russia, but it wasn't going to be Salomon Inc.

Russia, however, was merely a sideshow at the time. In 1989, the United States had become obsessed with the possibility that the whole country would be eclipsed by the rising sun of Japan. Salomon had invested large sums in Japan and was doing well in its start-up business there, which had grown rapidly to hundreds of employees and was making money under its head, Deryck Maughan, who had wisely given local talent the reins. Buffett, who generally did not buy foreign stocks and who believed Japanese stocks in particular to be outrageously expensive, had shown little interest in anything related to Japan. Katharine Graham, however, had developed a fascination with Akio Morita, one of the world's most brilliant businessmen. Morita was chairman of Sony, one of the world's most successful corporations. Graham brought the two men together at one of her dinners, but they did not click.

Finally, during one of Buffett's trips to New York, Morita-san held a small dinner for Graham, Buffett, and Meg Greenfield at his Fifth Avenue apartment overlooking the Metropolitan Museum. Buffett, who seemed slightly mystified by Graham's interest in this powerful, visionary man-observing grudgingly that Graham "was sort of enchanted by Morita"-agreed to go.

Buffett had never eaten Japanese food but knew it might be problematic. He went to plenty of events where he touched nothing more than the dinner rolls. He could easily go seven or eight hours at a time without eating. He disliked offending his hosts, however, and as his reputation had grown, he found that there was no way to fake eating by cutting things up and moving them around. People noticed.

One side of the Moritas' apartment had a sweeping view of Central Park, the other a sweeping view of the sushi kitchen. A highlight for guests was the opportunity to watch the four chefs preparing the elaborate meal behind a glass window.

As they were seated for dinner, Buffett looked at the chefs. What was this going to be like? he wondered. As guest of honor, he was seated facing the kitchen. There were chopsticks on a little stand and tiny cruets and miniature bowls of soy sauce. He already knew he didn't like soy sauce. The first course was brought out. Everyone slurped it down. Buffett mumbled an excuse. He motioned for his full plate to be taken away. The next course arrived. Buffett could not identify it but looked at it with dread. He saw that Meg Greenfield, who had eating habits similar to his, also was having difficulties. Mrs. Morita, seated next to him, smiled politely and barely spoke. Buffett gurgled another excuse. He nodded again for the waiter to remove his plate. As his untouched dishes returned to the kitchen, he was sure the chefs noticed.

The waiter brought out another unidentifiable course of something that looked rubbery and raw to him. Kay and the Moritas tucked in with enthusiasm. Mrs. Morita smiled politely once again when he offered a third excuse. Buffett squirmed. He liked his steaks bloody but did not eat raw fish. The waiter cleared the plates. The chefs kept their heads down. Buffett was sweating. He was running out of excuses. The chefs looked busy, but he was sure they must be peeking sideways from behind the glass to see what he would do. Course after course arrived, and each of his plates went back, untouched. He imagined that he heard a slight buzz from the kitchen. How many more courses could there possibly be? He had not realized there were this many things on the planet that could be eaten raw. Mrs. Morita seemed slightly embarrassed for him, but he wasn't sure, because she smiled politely all the time and said so little. Time crawled more slowly with each course. He had been counting, and the number of courses now exceeded ten. He tried to make up for his culinary lapses with witty, self-deprecating conversation about business with Morita-san, but he knew he was disgracing himself. Even in the middle of his bonfire of embarrassment, he could not help but think longingly of hamburgers. He was sure that the beehive in the kitchen was humming louder with every plate he sent back. By the end of fifteen courses, he had still not eaten a bite. The Moritas could not have been more polite, which added to his humiliation. He was desperate to escape back to Kay's apartment, where popcorn and peanuts and strawberry ice cream awaited him.

"It was the worst," he says about the meal he did not eat. "I've had others like that, but it was by far the worst. I will never eat Japanese food again."

Meanwhile, hundreds of Salomon employees who would have crawled up Fifth Avenue on their knees blindfolded to eat this same dinner with the Moritas were instead dining at high-priced Japanese restaurants and mutinying over the size of their huge bonus checks. The hugeness of their checks was not the point. It was the hugeness of their checks compared with others' huge checks that mattered. Buffett and Munger knew little of the trouble fomenting at Salomon. Meriwether's arbs had been agitating for more money. The former college professors, hired away from salaries of $29,000, felt they were subsidizing money-losing departments like equity investment banking. They viewed sharing their profits as "socialist."41 The arbs could have made more on their own. They wanted a cut of the hundreds of millions they earned for the firm.42 Although he was so shy that he had trouble maintaining eye contact, Meriwether now became the world's most aggressive and successful bonus pimp. Gutfreund caved and gave the arbs fifteen percent of what they made,43 which meant they had the potential to come away with much more money than the traders, who shared their bonus pool. The deal was made in secret between Gutfreund and Salomon's president, Tom Strauss; the board never knew, nor did other employees at Salomon-yet.

By 1991, Buffett and Munger had been through a series of disappointments and setbacks at Salomon. The financial results they got were not always up-to-date. Staff demands for bonuses continued to spiral. They disagreed with much of what went on in the boardroom. The stock price had not moved for eight years. Earnings were down $167 million, mostly because of employees' pay.

Buffett, having so far let Munger be the Appointed Bad Guy, now roused himself, met with the executive committee, and told them to cut back. Yet when the final bonus pool number came through, it was $7 million higher than before. Under the new formula that Meriwether, as bonus-pimp, had procured for his arb boys, one of them, Larry Hilibrand, got a raise from $3 to $23 million.44 When word of Hilibrand's bonus leaked to the press, some of his colleagues went crazy with envy and felt cheated-the millions they were making forgotten.

Buffett himself had no problem with the arbs' bonuses. "I believe in paying talent," he says, "but not, as Charlie would say, as a royalty on time." The arrangement was like a hedge fund's fee structure and bore some resemblance to his old partnership.45 It would put more pressure on the rest of the firm to perform. What he objected to was not being told. He objected even more to the fact that other people did not get haircuts for their lack of performance. Gutfreund had showed a better sense of proportion than most of his traders, opting to take a thirty-five percent pay cut, in line with the decline in earnings.46 This helped him with Buffett, who thought Gutfreund had more class than his employees. But Buffett's sense of decency was so offended by the employees' greed that he overcame his natural inertia and voted against the bonuses for the traders. He was overruled. When word of Buffett's "no" vote raced through the hallways of Salomon, people were outraged. A billionaire who loved money had called them greedy.

Buffett considered Salomon a casino with a restaurant out front.47 The restaurant was a loss-leader. The traders-especially Meriwether's people-were the casino: the purity of risk-taking done without conflicts of interest. That was the part of the business Buffett liked, and the new pay system was designed to keep the arbs from bolting.48 But by trying to operate the firm under two distinct pay systems, as if it really were a casino with a restaurant out front, Gutfreund had driven a rift through Salomon's heart.

Now Meriwether and Hilibrand asked Gutfreund for permission to approach Buffett to buy back his convertible preferred stock. The terms were so rich that it was costing Salomon too much. They were no longer under threat of a takeover. Why pay for Buffett's protection? Gutfreund said they could talk to Buffett and try to convince him he was better off without the preferred stock. When approached, Buffett said that he was amenable. But having Buffett as an investor must have made Gutfreund feel more secure, for in the end he got cold feet.49 Thus, Buffett was held to his original deal. Having invested both Berkshire's $700 million and his own reputation in John Gutfreund, by 1991 it was too late to back out.

48.

Thumb-Sucking, and Its Hollow-Cheeked Result New York City * 1991 On Thursday afternoon, August 8, 1991, Buffett was driving to Reno, Nevada, from Lake Tahoe on his annual weekend with Astrid and the Blumkin boys. He always looked forward to this trip and was in a relaxed and jovial mood. John Gutfreund's office had called him that morning. Where will you be tonight between nine p.m. E.S.T. and midnight? they asked. We want to talk to you.

Thinking this was really unusual, he said he was going to a show. They told him to call Wachtell, Lipton, Rosen & Katz, the law firm that represented Salomon, at seven-thirty p.m. Hmm, he thought. Maybe they're going to sell the firm. It sounded like good news to him. The stock was trading around $37, close to $38, the price at which his preferred stock would convert to common, and he could take his profits and be done with Salomon. Gutfreund, who had a long-standing habit of calling him for advice, might need help in negotiating terms.

Buffett and company whiled away the afternoon in Reno. Buffett reminisced. In 1980 he had been offered the entire contents of a Reno landmark, the Harrah Collection from the National Automobile Museum: 1,400 cars covering acres and acres, a 1932 Rolls-Royce salamanca, a 1922 Mercedes Targa Florio Racer, a 1932 Bugatti coupe, a 1955 Ferrari, a 1913 Pierce-Arrow. It would have cost him less than a million dollars for the whole collection. He had wavered, then passed. A few years later, part of the collection-hundreds of cars-had been gradually auctioned for a total of $69 million. One car, the Bugatti Royale, had recently been sold to a Houston real estate developer for $6.5 million.

By seven-thirty p.m., they had returned to Lake Tahoe. "We got to the hotel and the rest of them went into the dining room of the steak house. I told them, 'This may take a while.' I found a pay phone outside on the wall and dialed in to the number they gave me." Buffett expected to be connected with Gutfreund, but Gutfreund was on a plane from London, where he had been trying to save the firm's mandate in an investment banking deal for British Telecom. His flight had been delayed, and Buffett sat on hold for quite a while as a conversation took place on the other end about whether to wait for him to arrive before continuing. Finally Tom Strauss and Don Feuerstein got on the phone to tell Buffett what was going on-or a version of it, anyway.

Tom Strauss, forty-nine years old, was there to protect Gutfreund's flank. He had been appointed Salomon's president five years earlier, during the Great Purge of 1987.1 Responsible for the firm's international business, he was also charged with the Sisyphean task of licking the perennially lagging equity division into shape. As recent history showed, however, management was not a skill cultivated at Salomon. The warlords reported straight to Gutfreund, to the extent that they reported to anyone at all. Their clout came from their groups' production of revenues. Strauss might be technically president of Salomon, but he had been promoted so high that he now floated distantly above the trading floor like a helium balloon. Periodically, the warlords batted him out of the way.

Don Feuerstein, the head of Salomon's legal department, had once played an important role at the SEC and was regarded as an excellent technical lawyer.2 He was Gutfreund's consigliere, nicknamed POD, the "Prince of Darkness,"3 for the behind-the-scenes dirty work he did. Salomon's warlords, accustomed to doing whatever the hell they wanted, worked through lawyers who reported to Feuerstein, including Zachary Snow, the assistant general counsel assigned to the trading operations. The warlord structure made the legal department both powerful and weak; it stewarded the firm's franchise in much the way that everything happened at Salomon: by catering to factions and reacting to events. Salomon's trading culture had embedded itself so strongly that even Feuerstein was a trader, lovingly operating a wine syndicate on behalf of several managing directors. His fax machine constantly spewed forth notices of wine auctions that were a profitable sideline for the syndicate's participants, its product more traded and collected than drunk.4 This evening no one was toasting anything, however. Feuerstein knew that Buffett and Gutfreund were friends. He felt awkward giving sensitive information to Buffett when Gutfreund should have been in on the call. Using a set of "talking papers," he and Strauss told Buffett that "a problem" had arisen. A Wachtell, Lipton investigation had uncovered the fact that Paul Mozer, who ran Salomon's government-bond department, had broken the Treasury Department's auction-bidding rules several times in 1990 and 1991. Mozer and his deputy, who was complicit, were now suspended, and the firm was notifying the regulators.

Who the hell is Paul Mozer? Buffett wondered.

Paul Mozer, thirty-six years old, had been swooped up by New York from selling bonds in the Chicago office. He was as intense as a laser beam and started his day before the sun came up, parked in front of a trading screen in his bedroom taking a call from London, then galloped a couple of blocks from his tiny apartment in Battery Park City over to Salomon's enormous new trading room, housed in the gleaming pink-granite space of 7 World Trade Center. There he stared at another set of screens until past sunset, and oversaw twenty traders, most of whom towered over his short, wiry frame. Mozer was smart and hyper-aggressive, but he also struck people as frustrated and insecure, an odd duck. Although he'd grown up on Long Island, he seemed like a greenhorn from the Midwest among the slick New Yorkers. He had been one of Meriwether's arbitrage boys until Craig Coats, the head of the government desk, resigned and he was asked to take over. Now he still worked for Meriwether, but was on the outside looking in at his former gang. Gutfreund, who was under pressure from Buffett and the board to improve the numbers, had added the foreign-exchange department to Mozer's duties; in a few months he had turned a "black hole" around and made it profitable.5 So Gutfreund had reason to be grateful to Mozer.

While Mozer could be abrasive and condescending, as though he considered other people morons compared to himself, those who worked closely with him were fond of him. Unlike people on Salomon's infamous mortgage desk, he did not abuse trainees by hurling food at them or sending them racing out the door to buy twelve pizzas at a time. Sometimes he even talked to the trainees.

For his labors, Mozer had been paid $4.75 million that year. It was a lot of money, but it was not enough. Mozer was World Cupcompetitive, and Mozer was pissed. Something had snapped in him when he found out that his former colleague, Larry Hilibrand, had gotten 23 million bucks from a secret pay deal. He used to earn more than the arb boys,6 and he now went "ape-shit."7 He copped such an attitude that he demanded that his department not be audited-as if, somehow, oversight did not apply to him.8 Mozer was one of a few dozen men who communed regularly with the U.S. government on its financing needs, talking to the Federal Reserve staff nearly every day and dining quarterly with Treasury Department bureaucrats at the Madison Hotel. Representing Salomon as a "primary dealer," he offered the government market chatter and advice and, in turn, stood first in line as its largest customer whenever the government wanted to sell debt, like a member of the College of Cardinals who sat at the right hand of the Pope.

Only the primary dealers could buy bonds from the government. Everyone else had to do it by submitting bids through the primary dealers, who acted as brokers. This gave the dealers the clout that goes with access and enormous market share. Knowing the needs of both their clients and the government, the dealers clipped off a profit from the gap that lay between the supply and the demand. But with that position of power went a commensurate dose of trust. The government expected primary dealers to behave like cardinals who were celebrating Mass. Yes, they drank first from the communion cup, but they must not get loaded and embarrass the Church.

As an auction neared, the primary dealers would work the phones, polling customers to gauge their appetite for bonds. Mozer's sense of how hot the market was running translated into Salomon's bid. A few seconds before the clock struck one p.m. on the appointed day, the dealers phoned "runners," who stood by a wall of phones at the Federal Reserve Building downtown, waiting to scribble down orders by hand and dash to the Fed clerk's wooden box, where they jammed them inside. At the stroke of one p.m., the clerk placed his hand over the slot. That ended the auction. The government had used this antiquated system for decades.

The inherent tension of the market lay in the opposing interests of the Treasury and the dealers regarding pricing and amounts. The Treasury auctioned only a certain amount of bonds and wanted the highest price, while the dealers wanted to pay just enough in the auction to win a larger share than anyone else yet no more than necessary, for that would hurt their profit on resale. So finely calibrated were these bids that the traders used increments of 1/1,000th of a dollar. That sounds like almost nothing, but clipping off 1/1,000th of enough dollars amounted to a fortune. On $100 million, it was worth $100,000. On a billion dollars, it was worth $1 million. Because government bonds were less profitable than mortgages and corporate bonds, Treasury bonds had to be traded in blocks this size in order for the dealers and money managers to make enough money for it to be worth their while.

Dovetailing with the need for such large trades was the government's need to work with large dealers-those who knew the market well and had the power to distribute a lot of bonds. Salomon was the largest dealer by far. In the early 1980s, the Treasury had allowed any individual firm to buy up to half of a given bond issue for its own account. Salomon commonly "couped" an auction this way, then held on to the bonds long enough to "squeeze" anybody who was "short" Treasuries-having bet that prices would fall-because there were no bonds available for short-sellers to buy to cover their positions. Prices shot up, the short-sellers screamed, the trading floor erupted in cheers, and Salomon gloated over its huge profits and swung a big stick as the King of Wall Street. Couping the auctions fattened the usually thin profits on government bonds and sent a heady mist of testosterone drifting above the formerly stodgy section where the humdrum government-bond traders sat at their desks.

In response to grumbling, the Treasury lowered the limit and said no individual dealer could buy more than thirty-five percent, which made it harder to coup the auction. Smaller squeezes still occurred, but Salomon no longer owned the market unchallenged. Naturally, the new rule was unpopular at Salomon. Since the total of bids exceeded all the bonds on offer, the Treasury also prorated everyone, which meant a firm that wanted thirty-five percent had to bid more than thirty-five percent, a juggling act.

Thus in various ways the clampdown made it harder to profit at the government desk at Salomon. The mist of testosterone did not dissipate, however. Mozer tested the Treasury's patience twice in 1990, bidding more than one hundred percent of all the bonds to be issued. Michael Basham, who ran the auctions, told him not to do it again. Mozer was sent to an "apology breakfast" with Bob Glauber, an undersecretary of the Treasury. He squeaked out some words but did not exactly apologize. He claimed that overbidding was in the government's best interest because it increased demand for bonds.9 Not mollified, Basham changed the rules so that no individual firm could even bid more than thirty-five percent for its own account. The limit on bids meant Salomon might not even get its full thirty-five percent limit of bonds.

Now Feuerstein read Buffett a copy of a Salomon press release to be issued the next morning, which was being explained to all board members that night. It described how Mozer had responded to this stare-down with Basham. He had proceeded to submit unauthorized bids in excess of the government's bidding limit in the December 1990 and February 1991 auctions.

Feuerstein gave Buffett a scripted version of events and told him that he had already spoken at length with Munger, who was at his cabin in Minnesota.10 Munger had said to him something about thumb-sucking and added, "People do that all the time."11 Buffett recognized the term "thumb-sucking" as a Mungerism for procrastination but wasn't terribly concerned. Feuerstein did not mention anything else discussed in the lengthy conversation with Munger, and Buffett did not ponder whose thumb was being sucked. Seven or eight minutes later he got off the phone, recognizing that this wasn't the good news for which he had been hoping but not feeling alarmed enough to call Munger immediately. He'd check in with Munger over the weekend, he decided, but for now he was going to enjoy Lake Tahoe. Then he wandered back to join Astrid and the Blumkins in the dining room, where they were having a steak before seeing Joan Rivers and Neil Sedaka perform.

While Buffett was watching the show, John Gutfreund's plane from London finally landed. Gutfreund, Strauss, and Feuerstein had a conversation late that evening with Richard Breeden and Bill McLucas, top officials at the SEC. The three of them also placed a call to Gerald Corrigan, the beefy six-foot-four president of the New York branch of the Federal Reserve.

Using a different set of talking papers, Gutfreund and Strauss told Breeden, McLucas, and Corrigan more of the story than Salomon's board had just heard. Mozer had not just overbid. To get around the thirty-five percent limit, at the February 1991 Treasury auction he had entered a fake bid in the name of a customer and stashed the bonds he got in Salomon's account. In fact, he had placed more than one false bid in that auction. As to why these had not been reported earlier, they explained the delay as an oversight. Yet the SEC and the Treasury were in the midst of investigating Mozer, for he had pulled a huge squeeze in the May two-year-note auction. His actions were under intense scrutiny by regulators. That should have been true at Salomon as well. How could the delay have been an oversight? Now, the regulators had to consider whether this confession indicated some major systemic problem at Salomon.

No matter what, these admissions were going to be highly embarrassing to the Treasury and the Federal Reserve. Corrigan was shocked that the firm had not come to him saying that it had already fired Mozer and created a remedial program that involved instituting all sorts of new controls. But he expected something like that to be announced within twenty-four or forty-eight hours, after which he could "keep them on probation for a while and hope that would be the end of it." He told Gutfreund and Strauss, "patiently and dispassionately," as he recalls, that they had an immediate obligation to release this information to the public. Based on what he knew, he surmised that the incident could blow up into a "very, very, very significant problem."12 It seemed to him, however, that Strauss and Gutfreund did not fully grasp this. Indeed, with hindsight, the fact that Gutfreund had gone off to London, thus placing his ability to participate in the calls with Buffett, Munger, and the other directors in the hands of an airline, was itself a telling sign.

The next day, Friday, August 9, Buffett was enjoying himself with Astrid and the Blumkins, walking along the board sidewalks of Virginia City, the old Western gold-rush town. He called in to his office. Nothing urgent was happening. Nobody at Salomon had called him. Salomon had put out the press release describing the events in fairly bland terms. The stock had fallen five percent, however, to $34.75.

Buffett called Munger on Saturday at his cabin on Star Island in Minnesota. Munger flatly told him a much more detailed and alarming story. Feuerstein, reciting from the list of "talking points," had said that "one part of the problem has been known since last April." While these same words had been read to the other directors, including Buffett, they had the effect of technically informing without really enlightening.13 But Munger picked up instantly on bullshit legalese and the passive voice, which irritated him. What did that mean, "has been known"? What exactly had been known? And by whom?14 When pressed, Feuerstein gave Munger a much fuller description of events, similar to what Corrigan had been told.15 As Feuerstein recounted, Mozer had gotten a letter from the Treasury Department in April saying they were investigating one of his bids.16 Realizing that the game was up, on April 25 he had gone to his boss, John Meriwether, and made a confession of sorts. In February, to get around the thirty-five percent limit, he had not only bid in Salomon's name, he had also submitted phony bids under real customers' names.17 Mozer swore to Meriwether that this was the only time, and he would never do it again.

Meriwether had recognized immediately that this was "career-threatening," had said so to Mozer, and had reported the situation to Feuerstein and Strauss. On April 29, the three of them went to Gutfreund and told him what Mozer had confessed. Gutfreund, they said later, had been red-faced and pissed off when he heard the news.

Therefore, in April, Gutfreund knew. Strauss knew. Meriwether knew. Feuerstein, the general counsel, knew. They all knew.

Feuerstein had informed Gutfreund at the time that Mozer's actions appeared criminal. He didn't believe that the firm technically had a legal reporting requirement. Still, Feuerstein was sure that Salomon would run seriously afoul of the regulators if it didn't do something, and therefore the Federal Reserve must be told. Gutfreund said it would be taken care of. Curiously, however, no specific plans were made to march down to the Federal Reserve's ornate Italianate building and give Jerry Corrigan the news. Moreover, having concluded that the phony bid was a "one-time, aberrant act," they had decided to leave Mozer in charge of the government desk. Hearing this, "Well, that's just thumb-sucking," Munger had said. "People do that all the time." He later explained that by thumb-sucking he meant "sitting there thinking and doggling, musing, and consulting, when you should be acting."18 Munger told Buffett that he had challenged the press release: Shouldn't management's prior knowledge be disclosed? Feuerstein said that, yes, it should be, but the decision had been made not to because Salomon's management thought that disclosure would threaten the company's funding. Salomon had tens of billions of short-term commercial paper debt that rolled over day by day. If the word got out, lenders would refuse to renew. To Munger, "funding difficulties" was shorthand for "financial panic."19 Lacking the leverage to insist, he had given in, but he and Buffett now agreed that more disclosure was required. They mentally braced themselves for what would follow.

Two days later, on Monday morning, August 12, the Wall Street Journal reported the alleged details, with a blaring headline: "The Big Squeeze: Salomon's Admission of T-Note Infractions Gives Market a Jolt-Firm's Share of One Auction May Have Reached 85%; Investigations Under Way-How Much Did Bosses Know?" It mentioned the possibility of "civil charges of market manipulation, violations of the antifraud provisions of securities law, misrepresentations to federal authorities," "books and records violations," and "criminal charges" for committing "both wire and mail fraud."20 Gutfreund called Buffett, sounding calm. Buffett thought that he seemed to believe the whole situation meant "a few points on the stock." In light of the disastrous article, Buffett thought this attitude was unrealistic, a sign that Gutfreund believed the whole affair could somehow be finessed.21 It seemed of a piece with Gutfreund's unwarranted composure the previous week. Buffett pressed for more disclosure. Salomon's treasury division was beginning to have trouble rolling over its commercial paper, meaning the firm's lenders were starting to show signs of nervousness.22 Meanwhile, Munger was trying to get in touch with Wachtell, Lipton's Marty Lipton, who was John Gutfreund's indispensable best friend as well as Salomon's outside counsel. So entwined with Salomon was Lipton that the speed-dial buttons on Donald Feuerstein's phone rang his wife, the Sotheby's and Christie's auction houses, and Marty Lipton, not necessarily in that order.23 Munger knew that Lipton and his telephone were as inseparable as Buffett and his Wall Street Journal. Cell phones still being so rare, however, that even name partners of major law firms did not use them, Munger relied on Wachtell, Lipton's office, which, he would later observe to the SEC, had the "finest phone system for reaching Marty Lipton at any hour of the day or night that I have ever seen in the history of the world.... I think even if he was engaged in sexual intercourse, you could get through to him."24 Whether Lipton was horizontal when reached by Munger was never specified, but Munger badgered him for a follow-up press release, saying the first had been inadequate. Lipton agreed that the board would hold a telephone meeting to discuss it on Wednesday.

Not surprisingly, Jerry Corrigan at the Federal Reserve was even less satisfied than Munger with Salomon's muted response. On Monday, August 12, he decided to have Peter Sternlight, one of his executive vice presidents, draft a letter to Salomon Inc. stating that the firm's actions had called into question its "continuing business relationship" with the Fed, which was "deeply troubled" by the failure to make a timely disclosure of what the firm had learned. Salomon would have ten days to report on all "irregularities, violations, and oversights" that it had discovered.

In light of Corrigan's earlier conversation with Strauss and Gutfreund, this letter would be a death threat. If the Fed cut off Salomon's business relationship with the government, customers and lenders would desert in droves. The consequences would be huge and immediate.

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.25 Corrigan sat back in his chair, confident that once Salomon received Sternlight's letter, management would understand the loaded gun cocked at its head, and would respond accordingly.

Within Salomon, after the press release and the Wall Street Journal story, rumors were running wild. Late Monday afternoon, it held an all-hands-on-deck meeting in its huge auditorium on its lowest floor. Nearly five hundred people crowded in, while hundreds, maybe more, from upstairs and from Salomon offices around the world, watched on television screens. Gutfreund and Strauss walked the audience through a baked-Alaska version of events, a crisp well-done meringue of a surface that hid the chilly surprise. Afterward, Bill McIntosh, the head of the bond department, was summoned upstairs to Gutfreund's office, where he found Gutfreund, Strauss, and Marty Lipton, "three very scared men." Earlier in the day he had been calling for Gutfreund's head, but unexpectedly, they asked what he thought of the situation. McIntosh demanded more explanation; he felt the all-hands version and the press release had been misleading.26 He and assistant general counsel Zach Snow ended up getting drafted to write another press release.

The next morning, McIntosh and Snow began drafting. Around midday, McIntosh went to tell Deryck Maughan, the vice chairman of investment banking, who had just come back from running the firm's Asian operations, what was going on. Maughan knew he was hearing the harbinger of a disaster. He went to find Snow and pounced on him, saying you'd better be telling the whole truth to a vice chairman.

But Snow had no intention of hiding anything from Maughan. He started talking, and a tale unfolded of what had transpired behind the scenes. He explained that in April, after Mozer made his first confession about the February auction, Meriwether had pleaded that Mozer not be fired, even though Feuerstein had said he believed Mozer's actions were criminal in nature. Snow had been told-in confidence-about the situation. A month later, Mozer still ran the government desk; Feuerstein was nagging Gutfreund to come clean; Gutfreund was telling him that he would. But in fact no one had told the government. Meanwhile, Meriwether was charged with keeping an eye on Mozer, who had supposedly reformed.

Then Mozer had asked for funding to bid on more than one hundred percent of the two-year-note auction in late May. Even though some of the funding was supposedly to put in bids for customers, John Macfarlane, Salomon's treasurer, had become alarmed. He thought it an obvious red flag and called a meeting with Snow and Meriwether. Snow had gone to Feuerstein, his boss, who agreed that it was an outrageous request. They had decided not to give Mozer the funds.27 But Mozer had secretly juggled the bids and money anyway.28 Managing to evade his overseers, he put in one suspicious bid and pulled off an enormous auction coup. Salomon wound up with eighty-seven percent of the Treasury bonds, and it and a small group of customers controlled the two-year notes afterward. The price shot up.29 Others' losses from the "squeeze" topped $100 million, and several small firms suffered so severely that they filed for bankruptcy.30 Within Salomon, the squeeze had caused considerable angst. In the press, the firm was painted by its competitors as the pirate of Wall Street. The board members, including Buffett, had expressed outrage at a meeting that Salomon had cornered the market for two-year notes. Feuerstein had had Snow commence an internal investigation of the squeeze in June. As it turned out, Mozer had held a dinner with two hedge-fund customers right before the auction, and these customers had placed bids involved in the squeeze. With hindsight, the dinner pointed to possible collusion and market manipulation. But in the absence of proof, Mozer explained it away.31 Gutfreund had set up a meeting to see his overlords at the Treasury and the Fed to mend fences over the squeeze. When he went to see Glauber in mid-June, he sat on the sofa puffing a cigar. He offered a mea culpa to Glauber for the aftereffects of the squeeze and offered to cooperate with the Treasury-but defended Mozer against allegations of intentionally rigging the May auction. And he made no mention of what else he knew, leaving out anything about Mozer's false bids in the earlier auction. In response to the squeeze and to the earlier run-ins with Mozer, however, unbeknownst to anyone at Salomon, the SEC and the Antitrust Division of the Justice Department began investigating the firm anyway.

About a week after the Glauber meeting, Gutfreund, Strauss, and Meriwether met to consider whether the firm should now come clean with the Treasury about the February auction. Because the hue and cry over the squeeze had not abated, they decided to keep silent. They felt the time was not right. Days later, the SEC sent Salomon a letter asking for information about the May auction. This was the first indication that the problem of the two-year note auction might be escalating instead of fading away. Anyone receiving this inquiry letter might reasonably have gotten nervous about the SEC's sudden interest in the operations of the government-bond trading desk.

Two days later, Gutfreund had flown to Omaha to visit Buffett, while on his way to Las Vegas to see some property that Salomon had financed. In telling the backstory to Maughan, Snow, who did not know about this trip, left it out. Buffett would later fill in these details.

"I picked him up at the airport. John was in the office for about an hour and a half. He spent about an hour making some calls, then we talked for about half an hour. He was sort of pacing around. We didn't talk about anything in the end. It's a pain in the neck to stop in Omaha, yet he really had nothing to say."

Somewhat baffled as to the purpose of the visit, Buffett took Gutfreund to a quick lunch, then for a visit to the recently acquired Borsheim's jewelry store, near the Furniture Mart. The proprietor, Ike Friedman, Mrs. B's nephew, was cast in the same mold, and like her, somewhat larger than life.

Friedman took Gutfreund to Borsheim's "center island," where the really expensive goods were displayed. Gutfreund picked out a $60,000 item for Susan. It mattered to Buffett, Gutfreund said later, that he had made a purchase.32 Then he glanced at the expensive watches strategically displayed just behind the center island, and strolled over to look at the merchandise. Friedman preferred selling very expensive jewelry to timepieces. "Oh, watches," he said to Gutfreund. "You lose them, you break them. Why pay a lot of money for a watch?" He looked at the fancy wristwatch on Gutfreund's wrist and asked Gutfreund what he paid for it. Gutfreund told him.

"$1,995,"33 Friedman repeated. "Well. You got taken, John."

"And you should have seen the look on John's face."

Wearing the watch on which he got taken, Gutfreund returned to New York at the end of June to present the burgundy-colored satin-lined Borsheim's box to Susan.

Within days-by early July-the Antitrust Division of the Justice Department formally notified Salomon that it was investigating the squeeze in the May two-year-note auction, which the letter from the SEC had inquired about. Gutfreund now got serious, said Snow, and hired Marty Lipton's firm Wachtell, Lipton, Salomon's outside counsel, to begin its own investigation, on behalf of Salomon, of the circumstances surrounding the May squeeze.34 People within Salomon had mixed views about the squeeze. Some said the Treasury market was inherently designed to be collusive. The job of a dealer was to work with its customers to distribute huge blocks of bonds into the market. Little squeezes happened all the time. This one was big. So what? The Treasury was picking on Salomon. It was the years of hubris, the wildness depicted in Liar's Poker, the gradual erosion of power that had made Salomon a punching bag.35 But others were furious that Mozer had once again defied the Treasury. They were baffled that he would pull a huge squeeze when it was well-known that he and Basham were already at loggerheads. Later, these questions would increase. Why did Mozer-on probation, told his behavior had been "probably criminal"-taunt the Treasury so outlandishly that his coup splashed headlines all over the financial press, in a way guaranteed to draw even more attention to himself?36 Snow, who reported to Feuerstein on trading operations, had been in charge of the internal investigation involving the May squeeze. In June, he was out of the office some of the time with knee surgery, and neither he nor Feuerstein was involved in the Glauber meeting, nor knew about the subsequent decision to further delay reporting Mozer's actions.37 But once Snow returned full-time to the office in July, increasingly he started to realize that he was out of the loop. People began disappearing into meetings. The situation preyed on his mind. One night he had a dream. He walked into Feuerstein's office the next morning and said he had dreamed that he and Feuerstein had actually called Warren Buffett and told him about the false bid, because they were both so frustrated that Gutfreund and Strauss had done nothing about it.

Feuerstein looked at Snow cross-eyed. "No, no," he said. "It won't come to that." Feuerstein was still trying to influence Gutfreund. Going to Buffett would be throwing that relationship away.38 Snow had not intended his account of the dream to come across as a subtle threat to bypass his boss and call Buffett, but he thought Feuerstein seemed to have taken it that way.39 A few days after beginning their work, the Wachtell, Lipton investigators had returned with a preliminary report on the May squeeze. Only now, however, were the investigators told that senior management had known since April that Mozer had submitted an unauthorized bid in the February auction.

With hindsight, Salomon's actions looked far worse. After learning of Mozer's false bid in February, which Feuerstein had said was criminal in nature, management had taken Meriwether's vouching for Mozer and Mozer's word that he had never done it before, without investigating further or disciplining Mozer in any way. They had left him in place, which allowed the May squeeze to occur. Once it did occur, Salomon was in more trouble, because telling the government they knew about Mozer's previous phony bids but had only now reported them would probably have conveyed the sense that Salomon was a gang of thieves. Worst of all, Gutfreund had met with Bob Glauber in mid-June about the May squeeze, but had said nothing about all these earlier events. Now, as Snow explained to Maughan, when things started blowing up, everyone involved started excusing the original delay by saying the matter was a single minor event that caused no customer any harm, cost the government nothing, and didn't make sense, even from the standpoint of the trader involved.40 Given the pressure of business, Gutfreund said, he simply hadn't deemed it that important.41 Unfortunately, he was wrong about that. The Wachtell investigators had discovered that the February auction was not the only one that Mozer had rigged. They now knew that five auctions had been compromised.42 Two of these false bids had only just been unearthed. Snow concluded by telling Maughan about the previous evening's meeting with all the inside and outside lawyers that had followed the half-baked explanation given to all employees. Snow had argued that management's prior knowledge had to be disclosed. He was batted down. "I'm going to take a lot of heat for this," Gutfreund told him. "I don't see why you can't do your part."43 Maughan had been deeply concerned even before hearing all this new information from Snow. Seven days had passed since the first press release-seven days that included a salvo of stories in the media, the firm's falling stock price, trouble rolling over the commercial paper, the discovery of new false bids, and Gutfreund and Strauss feeding baked Alaska to the troops at an internal meeting. By the time Snow finished telling him all of this additional history of what Mozer had done and what others had not done, Maughan blew up and started pounding Snow to make sure there was nothing else. Then he went down to the trading floor and confronted Meriwether, Mozer's boss. "What the hell is going on, John?" he asked.

Meriwether hung his head. "It's too late," he said. He refused to talk further.44 Too late or not, Snow and McIntosh had to spend the evening drafting a second press release to try to explain things. That same night, Strauss and Gutfreund called Corrigan to respond in some fashion to the Sternlight "cocked gun" letter, which the firm had received that morning. Realizing that he was on a speakerphone, Corrigan assumed that a room full of undisclosed lawyers was listening to everything he said. The conversation started out with Corrigan being told that the firm had done an investigation and that "industry practice" of other firms was to pad their bids for new issuances of municipals and agency securities to get a bigger share. Corrigan viewed this opener as "a diversion, or worse." It had nothing to do with the squeeze, nor with the more serious issue of phony bids-in fact, nothing to do with the Treasury market. His Irish temper ignited. He yelled into the phone at Strauss and Gutfreund: "I'm sure you've got a room full of [bleeping] lawyers. This is your last chance. Is there anything else you have to tell me?" They began to describe the other violations.

Corrigan meant to put an end to the obfuscations and rationalizations. "Well, goddammit," he said, "get yourselves together and release all of this information to the public immediately. I don't want to hear anything else from you, just get that goddamn press release out."45 Late that evening, the lawyers met with senior management to go over the press release. Gutfreund and Strauss arrived. McIntosh said there needed to be heads on a plate. This idea was quickly dismissed, but other people, including a board member, Gedale Horowitz, and Steve Bell, who ran Salomon's Washington office, pressed for fuller disclosure. Nobody could get hold of Buffett, but they reached Munger on the phone, who said, Look, you can't put this second press release out without names. Gutfreund's name went in automatically. Everyone knew that Strauss was not in charge and had not made any of these decisions; he had simply been present in the room. But he had gone along with his boss. His name went in. Feuerstein had tried to get Gutfreund to report it. Munger said that his name should stay out.

Meriwether was known as a brilliant, careful manager who was unusually close to his team and rarely left the desk. He had reported the matter exactly as he should.46 On the other hand, he had vouched for Mozer, pleaded his cause, then left Mozer's responsibilities unchanged. When Munger said Meriwether's name should go in, says McIntosh, Meriwether, listening and seeing the lawyers write down his name, said, "Oh, my God, I'm doomed."47 The next day, Wednesday, August 14, a telephone meeting took place in which the board heard some of the story that was given to Corrigan the night before. Two board members called in from Europe, one from Alaska, Buffett from Omaha, and Munger from Minnesota to hear the first "orderly and halfway complete description" of the Mozer affair. Inside Salomon, a palace coup was well under way, with senior managers talking to one another on the assumption that Gutfreund and Strauss would have to resign.48 The arbs wanted Meriwether as CEO, which was clearly unacceptable to many people given that he was Mozer's boss; the arbs then floated the idea that Deryck Maughan might serve as co-CEO with Meriwether. Meanwhile, no one on the board conference call said anything about management changes; they merely debated the wording of the new press release, which contained three pages of details and added the two additional violations that had been discovered by the investigators.

The draft release admitted that management had known about the February bids as far back as April but said that "the press of business" kept Salomon from reporting Mozer's actions to the authorities. Buffett called this ridiculous, and as the board debated, Munger became incensed. Eventually, the press release was rewritten to say that the failure occurred due to "lack of sufficient attention to the matter," leaving the impression that the names in the press release were the people who were not paying attention. Arrangements were made to put out the release that night.

As the meeting concluded, the board thought it had the full story. A number of things had not been mentioned, however. One was the "cocked gun" letter just received from Peter Sternlight at the Fed. Another was the June meeting with Bob Glauber at the Treasury Department, at which Gutfreund had failed to mention Mozer's earlier activities.

That afternoon, Salomon held another all-hands-on-deck meeting in the auditorium. Bill McIntosh, who ran the daily sales meeting, stood at the front as usual and had the unenviable job of reading the new press release to the employees. With Gutfreund and Strauss in the front row, directly opposite him, McIntosh said, This is what happened. If customers call and want to know what's going on, just tell them. Make no excuses for senior management, don't apologize for them, they did what they did.

Afterward, the salespeople piled into McIntosh's office. What are we supposed to say? they begged. Don't make excuses for senior management, McIntosh repeated. In my view they're not going to last very long; they're gone; they're yesterday's news; we've got to keep this place together so we can survive and play another day. Focus on that.49 That evening the government-bond department showed up on the terrace of McIntosh's duplex overlooking the Hudson River in the West Village for a previously scheduled barbecue. Eerily, Tom Strauss dropped by-and the temperature on the deck fell several degrees.50 Instead of hanging around until ten or eleven swigging beer as usual, everyone cleared out by eight o'clock.

The morning after the press release appeared, Thursday, August 15, rumors floated that the long knives were out and McIntosh was a goner. He stayed on the floor all day, figuring that Gutfreund and Strauss wouldn't fire him for insubordination in front of the whole trading floor. Meanwhile, market confidence in Salomon cracked. The stock, which had been sinking all week from the previous Thursday's close of almost $37, slumped to $27. It was trading down because shareholders were beginning to suspect a bigger problem than Mozer's misdeeds: a "run on the bank." And, indeed, one was beginning to take place.

Photo Insert Three

Image 48

Chuck Rickershauser, the lawyer who said around 1976 of the convoluted business created by Buffett: "There's got to be an indictment in here somewhere."

Image 49

Tooting a trumpet in his bathrobe. Ever since his boyhood fiasco at Rosehill Elementary, Buffett refuses to play the "echo."

Image 50

Charlie Munger reading with his grandchildren.