Berkshire Hathaway Part II

In Part II of our Berkshire Hathaway Trilogy (!), we pick up the story with Warren wandering in the woods of Omaha, searching for his life's next chapter after retiring from the professional investing business at the top of his game at age 39. How does he emerge from those woods anew, transforming from Ben Graham's cigar-butt cocoon into the butterfly collector of Berkshire's wonderful businesses? (Spoiler: Charlie Munger.) And how did one rotten-to-the-core business nearly bring it all down — everything he'd ever worked for — in the span of one terrible week? Tune in! Sponsors: Vanta: https://bit.ly/acquiredvantaServiceNow: https://bit.ly/acquiredservicenow26Legora: https://bit.ly/acquiredlegoraStatsig: https://bit.ly/acquiredstatsig26 More Acquired! Get email updates https://www.acquired.fm/email with hints on next episode and follow-ups from recent episodesJoin the Slack http://acquired.fm/slackSubscribe to ACQ2 https://pod.link/acquiredlpMerch Store https://www.acquired.fm/store! © Copyright 2015-2026 ACQ, LLC The Charlie Munger Playbook is available on our website at https://www.acquired.fm/episodes/berkshire-hathaway-part-ii Links: Chuck Rickershauser's corporate flow chart: (left half https://www.google.com/imgres?imgurl=http://li395-204.members.linode.com/the-snowball/OEBPS/images/Schr_9780553905496_epub_056_r1.jpg&imgrefurl=http://li395-204.members.linode.com/the-snowball/OEBPS/Schr_9780553905496_epub_c39_r1.htm&tbnid=9dIO9Wp7IpyywM&vet=1&docid=DlnKeBiag8VefM&w=340&h=472&itg=1&hl=en&source=sh/x/im) (right half https://www.google.com/imgres?imgurl=http://li395-204.members.linode.com/the-snowball/OEBPS/images/Schr_9780553905496_epub_057_r1.jpg&imgrefurl=http://li395-204.members.linode.com/the-snowball/OEBPS/Schr_9780553905496_epub_c39_r1.htm&tbnid=8sq6rOGJNv-eEM&vet=1&docid=DlnKeBiag8VefM&w=332&h=474&itg=1&hl=en&source=sh/x/im) Carve Outs: The Sopranos: https://www.hbo.com/the-sopranosMacklemore on Armchair Expert: https://armchairexpertpod.com/pods/macklemore

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00David Rosenthal?

  Guess how many grams of sugar are in this normal looking sized bottle of Cherry Coke?

• 0:07Ben Gilbert?

  Is that 20 ounce?

• 0:08David Rosenthal?

  It is 20 ounce. Yep.

• 0:10Ben Gilbert?

  Uh, 40.

• 0:14David Rosenthal?

  Nope.

• 0:15Ben Gilbert?

  50.

• 0:16David Rosenthal?

  70.

• 0:18Ben Gilbert?

  In a 20 ounce bottle, there's 70 grams of sugar?

• 0:21David Rosenthal?

  70 grams of sugar in one 20 ounce bottle.

• 0:26Ben Gilbert?

  Wow.

• 0:27David Rosenthal?

  I can't believe they still sell this stuff.

• 0:40Ben Gilbert?

  Welcome to season eight, episode six of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert, and I am the co-founder and managing director of Seattle-based Pioneer Square Labs and our venture fund, PSL Ventures.

• 0:56David Rosenthal?

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

• 1:02Ben Gilbert?

  And we are your hosts. On our last episode, we told the story of Warren Buffett in the years of running his own partnerships, those 12 years leading up through 1969, when he shut it down after his best year ever and returned all the money to his investors. Today, we will pick up right where we left off, telling the story of the declining suitliner manufacturer that he bought Berkshire Hathaway. Today's story is one of an investment style in transition from a focus on cigar butts to a focus on wonderful businesses, much of which was inspired by the man we've only briefly mentioned so far, Charlie Munger.

• 1:43Ben Gilbert?

  Now, you may be thinking to yourself, boy, it'll be really great to get the other half of the Berkshire story to understand where they are today. Unfortunately, you should know David and I better than that. We were foolish to think that we could tell the whole Berkshire story in a mere two episodes. So this episode is our Empire Strikes Back. It will serve as a bridge between the early forces that made Warren and the mature Berkshire that we have today. What made Buffett start investing again after dissolving his partnership? And why on earth did he decide to do that inside of the shell of the declining Berkshire instead of just starting a new fund?

• 2:23Ben Gilbert?

  And even how did he end up briefly as the chairman of a Wall Street bank with a culture that he had criticized for his whole investing career? So here we are, part two of our Berkshire Hathaway trilogy.

• 2:39David Rosenthal?

  This really is the Empire Strikes Back. It's going to get dark at the end.

• 2:42Ben Gilbert?

  Truly.

• 2:43David Rosenthal?

  Be prepared.

• 2:44Ben Gilbert?

  There's a little bit of an apt analogy there. It's true. Well, folks, are you an acquired Slack member yet? If not, what on earth have you been waiting for? It is a wonderful community discussing, of course, all things acquired in recent episodes, but more importantly, it is a smart group of people having thoughtful, nuanced and respectful discussion about tech investing. You can join at acquired.fm/slash/Slack. All right, listeners, now is a great time to tell you about a longtime friend of the show, Vanta. AI has scrambled the whole security picture. It used to be that you proved that you were secure once a year on audit or a static PDF, then everyone would nod and you're done. But in an AI-first world, that doesn't hold up anymore.

• 3:28David Rosenthal?

  Yep, your risk surface changes every week now. A vendor turns on an AI feature or someone writes in a new model without telling IT and your posture is different than it was last week, let alone at your last audit. Vanta's own research found that around 70% of companies have this quote unquote "shadow AI" running with no security review at all.

• 3:48Ben Gilbert?

  Right, and that's where Vanta comes in. They're the leading agentic trust platform, meaning they've built the thing that closes the gap. And the way that they close that gap is Vanta Agent. Think of it as a GRC engineer, that's Governance, Risk and Compliance, except that it's software and it doesn't sleep. It finds the issues, drafts the fixes and cuts the time that you'd spend on vendor assessments in half.

• 4:10David Rosenthal?

  In half, which is exactly why more than 16,000 companies today run on Vanta. Companies like Ramp, Cursor and Snowflake all stay audit-ready and catch the risks that crop up between audits across every vendor, every AI tool, the whole environment.

• 4:29Ben Gilbert?

  And that's the real value. Trust has to be continuous now, which is why Vanta automates your Security, your compliance and the work to earn and prove trust. We're huge fans of Vanta over here and literally hundreds of acquired listeners have become Vanta customers at their companies over the years. So you can get $1,000 off Vanta at vanta.com/acquired. That's V A N T A dot com slash acquired for $1,000 off and just tell them that Ben and David sent you. Now, lastly, if you aren't an LP, you should become one. Aside from all the things that we tell you every time, we have a brand new LP event coming up that we are super excited about. Our next book club will be with Brad Stone, who famously wrote The Everything Store,

• 5:14Ben Gilbert?

  The Upstarts, and now David, what is his new book?

• 5:17David Rosenthal?

  Amazon Unbound.

• 5:19Ben Gilbert?

  Part two of the Amazon story.

• 5:21David Rosenthal?

  Just like this is part two of the Berkshire story.

• 5:24Ben Gilbert?

  So our new format for the book club will be that David and I are going to interview Brad. And if you're an LP, then you you get to join on the Zoom as well and we'll have time for Q and A and everybody will hopefully have read the book before we do the interview. So you can join at acquired.fm/lp and learn more about that program. All right, David, before you take us in and listeners, as always, the show is not investment advice. David and I may, and I think we've already told you that we do have investments in the companies that are discussed on this episode and this show is for educational and entertainment purposes only.

• 6:00David Rosenthal?

  All right, let's get to it. We got a lot to get through here.

• 6:03Ben Gilbert?

  Yep.

• 6:03David Rosenthal?

  So last we left our friend Warren Skywalker, Warren Buffett. He was wandering in the woods of Omaha after having closed down the partnership, as you alluded to Ben, and trying to figure out what to do with his life and his retirement. So before we pick back up with that story, though, I think we have some unfinished business and a character that we need to introduce here.

• 6:30Ben Gilbert?

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

• 6:41David Rosenthal?

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

• 6:53Ben Gilbert?

  That sounds like six years before Warren was born.

• 6:56David Rosenthal?

  Yep, six and a half years before Warren was born, where in Omaha, Al and Florence Munger. Florence gives birth to a baby boy whom they name Charles Thomas Munger, after his grandfather, who is a widely respected federal judge in the Nebraska US District Court, appointed by Teddy Roosevelt himself, Thomas Charles Munger. So Charles Thomas Munger, name for his grandfather, Thomas Charles Munger. And he takes after his grandfather in many ways, his grandfather makes a big impression on him. Thomas's mantra in life was concentrate on the task immediately in front of you and

• 7:41David Rosenthal?

  control your spending. Sort of sounds similar to Ernest Buffett, similar ideals. And this kind of instills this idea of gaining wealth through controlling your spending and focusing on doing a great job at the task in front of you in young Charlie. And Charlie, much like Warren, decides that he wants to become wealthy so that he can not have lots of fancy toys to play with, but so that he can be independent. He has a quote, he says, "I wanted to get rich so I could be independent, like Lord John Maynard Keynes." Of course, elementary school aged Charlie Munger is aspiring to be like John Maynard Keynes. So this is where he's a little different than Warren. They really have the same aims and goals in life, but their sort of, their styles

• 8:25David Rosenthal?

  around it are very different. Warren is just like, "I don't want anybody telling me what to do." Charlie's like, "Oh, I want to be like Lord Keynes." So as we chronicled in part one, Charlie actually goes to work for Ernest Buffett at the grocery store as a kid. Unbelievable for Warren's grandfather. Just like Warren learns he hates manual labor and being paid a pittance of salary and he thinks there's got to be a better way. He can use his mind to make money rather than his manual labor.

• 9:00David Rosenthal?

  And speaking of his mind, he loves to read. His parents give him and his sisters lots of books. He tears through them and very early in life, he stumbles across Ben Franklin. And Ben Franklin would become his hero in life. And that's where he develops this idea. I don't know if he stole it from Franklin or if he came up with it himself of making friends of the eminent dead. He decides he enjoys more the company of dead people and learning from them through their books than people who are actually alive.

• 9:32Ben Gilbert?

  Kind of a one way conversation, but there's probably a lot, a lot of wisdom there. Not to mention like revisionist histories and survivorship bias, yada, yada, yada.

• 9:41David Rosenthal?

  I think a lot of conversations with Charlie are one way conversations as we shall see. So also Lake Warren, he's, he's kind of a wise ass as a kid and has a very high opinion of himself. His neighbor, one Ed Davis, who we discussed in part one, the doctor, is his father Al's best friend.

• 10:01Ben Gilbert?

  And, and just as a refresher, the Davises would become one of the first families to invest in Buffett's first partnership, right?

• 10:08David Rosenthal?

  Yeah. And I think the first, if I remember right, the family in Omaha that gave him the most money of sort of the initial group, I think they gave him a hundred thousand dollars because Warren reminded them of Charlie. So he ends up going to Michigan for undergrad. Sorry, Ben.

• 10:26Ben Gilbert?

  It's all right. These days I'm not sure there's much of a rivalry anyway.

• 10:29David Rosenthal?

  Oh, burn, burn, of course. Ben went to Ohio State. So where at Michigan, he majors in math and gets turned on to physics where he becomes really entranced with physics. And then while he's still at Michigan, Pearl Harbor happens and the US enters World War II, Charlie joins the air force. And as part of the intake process, they measure his IQ and he's literally like one of the top IQ scores that the military and like Eddie Brandt has ever tested.

• 11:03Ben Gilbert?

  No, no major surprise there.

• 11:05David Rosenthal?

  Yeah, no major surprise.

• 11:06Ben Gilbert?

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

• 11:11David Rosenthal?

  That is definitely true. So they send him first to the University of New Mexico to study engineering there. He then goes on to Caltech in Pasadena in Los Angeles and continues his engineering studies there. And then I think he ends up, if I'm remembering this right, I don't have it in my notes, I think he ends up getting stationed in Alaska as a meteorologist during the war.

• 11:36Ben Gilbert?

  I remember him being in Alaska too, as part of his duty.

• 11:39David Rosenthal?

  Yeah. So anyway, after the war, he decides that he really enjoyed learning about engineering and physics and math and all that. But for a career, he more wants to follow in the family footsteps of his beloved grandfather and his father and go into the law. So Charlie being Charlie, he applies to Harvard Law, despite the fact that he doesn't have an undergraduate degree.

• 12:05Ben Gilbert?

  Why should that stop him?

• 12:06David Rosenthal?

  Yeah, he didn't actually graduate from any of these institutions. And he gets in and he goes to Harvard Law. He does very well there, graduates Phi Beta Kappa. And he decides after graduation, he's thinking about going back to Omaha, but he decides, well, one, Pasadena was, it was really nice when I was there at Caltech. The weather in LA is hard to beat. But also, in typical Charlie fashion, he sort of asked himself a rhetorical question. He's like, where can I be somebody? And, you know, Omaha is obviously a right, a rising town, great city, but, but it's not Los Angeles. And he says, what city is, is growing and full of opportunity so that I could make a lot of money, but not

• 12:51David Rosenthal?

  so big and well-developed that it would be hard to rise into the ranks of the city's most prominent men, which of course Charlie wants to be among those ranks.

• 13:01Ben Gilbert?

  And it's, you're already seeing a massive departure in the sort of psychological makeup of Warren and Charlie here, where like, that was never a thing Warren cared about. It was like, how much money will I have on the scoreboard when I die? And like, I'm sure no matter where I live, that'll get compared to everyone else. And for Charlie, it was, you know, where can I be a man about town? And that town should be

• 13:22David Rosenthal?

  Exactly.

• 13:23Ben Gilbert?

  big enough to be worth being a man about town. And it's also funny to me that at this point, like LA is for him, something that he views as like, oh, it's not too big yet.

• 13:32David Rosenthal?

  Yeah. Well, it wasn't. I mean, right after World War II, obviously, it was a big town and Hollywood had always been there, but I think California, and particularly Southern California, experienced a huge population boom after World War II, of which Charlie was part. So very tragically, after moving to LA, he had gotten married, I think, right after the war, when he started at Harvard. And tragically, both his marriages falling apart when he gets to LA. And much more tragically, his son Teddy is diagnosed with leukemia. And in those days, there was no effective treatment for leukemia.

• 14:11Ben Gilbert?

  Yeah, just tragic.

• 14:13David Rosenthal?

  It was totally tragic. And Teddy would end up passing away in 1955 at age nine, which is unimaginable to lose a child at all, let alone in that way and at that age. Charlie's reaction to this, I think, is very characteristic, very telling of who he is. He's obviously absolutely devastated, but he decides that the thing to do is he needs to set new goals for himself and move forward versus being consumed by grief. So he says after about when reflecting on this time, he says one of his Charlieisms, "You should

• 14:52David Rosenthal?

  never, when facing some unbelievable tragedy, let one tragedy increase into two or three through your failure of will," which is probably, you know, sound advice. Not that I can imagine going through that.

• 15:07Ben Gilbert?

  That's also some incredible compartmentalization. I mean, for, imagine going and speaking to a person who's grieving right now and telling them, "Hey, don't let this turn into two or three cascading," what is it, failures or catastrophes? It's all sort of only something you can decide and tell yourself. And I think only if you are a person like Charlie.

• 15:28David Rosenthal?

  Like Charlie. So he sets two very specific goals for himself. One, to find a new spouse and two, to diversify his business activities outside of law. And so on, one, I thought this was so funny. He's really worried. He's now a divorced man in his 30s in California. He doesn't know that many people out there. He goes through all the math of like, how many women are there in California? How many would be of a marriageable age? How many are smart enough for me, but not too smart? Of course, this is Charlie. So he happens on a foolproof strategy. He decides that he's going to do the most rational thing possible.

• 16:08David Rosenthal?

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

• 16:16David Rosenthal?

  For widows and recent divorcees.

• 16:21Ben Gilbert?

  Oh, my God.

• 16:22David Rosenthal?

  I guess, I guess there weren't dating websites back in those days. So that's what you had to do. His friends are kind of alarmed by this. And one of his law partners introduces him to a woman named Nancy Borthwick, who was, kind of fit all of his criteria, except maybe the not being too smart. She was quite smart. She was recently divorced. She was Phi Beta Kappa from Stanford undergrad in economics. She actually had an undergrad degree, unlike Charlie. And most importantly, see, she took nobody's crap, including Charlie's. So they, each of the two of them have two children, two surviving children from their previous marriages. They get married, they go on to have four more children together

• 17:05David Rosenthal?

  for an entire Munger clan of 10 people, eight children and two parents.

• 17:13Ben Gilbert?

  It's a lot of Mungers.

• 17:14David Rosenthal?

  That is a lot of Mungers. And if you see photos of them, of the Munger clan to this day, especially with all the grandchildren, it is impressive. It's like a small city.

• 17:24Ben Gilbert?

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

• 17:31David Rosenthal?

  Uh, yes, her name.

• 17:33Ben Gilbert?

  Yeah, they're both named Nancy. Like,

• 17:36David Rosenthal?

  Yeah.

• 17:36Ben Gilbert?

  In some ways, you're like, come on, that's pretty lazy. Like, you can't go marry someone again with your same. Someone once made a remark that Charlie was so sort of absent minded and forgetful of names that, thank God, his, uh, his second wife was also named Nancy, or he would have forgotten her name, too.

• 17:51David Rosenthal?

  Yeah, very Charlie. He is unique. So on goal number two, he's doing very well as a lawyer in LA. As you can imagine, Charlie is an excellent attorney, but he decides that, uh, you know, even though he's having all this success, really, the people who seem like they have the good life and who are really the sort of, you know, men, and they're all men at this point about town, are the clients. In particular, one of his clients is the mining magnet Harvey Mudd, who helped build Caltech into what it became and then helped build and found all of the Claremont Colleges, including the one that bears his name, Harvey Mudd. He was one of Charlie's clients. So what does Charlie do?

• 18:33David Rosenthal?

  He starts buying some stocks himself, but he also starts taking some of his fees from his clients in equity, in addition to cash. Yeah, he's like, uh, he's like the early, you know, Silicon Valley, you know, entrepreneurial startup lawyer type that takes some, takes some equity in addition to cash for doing the deals. He also ends up getting into real estate, which real estate in Southern California in the post-war era was a great way to make a lot of money. He gets his net worth up to about one and a half million dollars by the early 60s, which if you remember from part one, he's like right neck and neck with Warren at this point in time.

• 19:15Ben Gilbert?

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

• 19:18David Rosenthal?

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

• 19:26Ben Gilbert?

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

• 19:35David Rosenthal?

  Totally, totally. Which, unlike Warren, Charlie's not necessarily against something like that. He's definitely enjoying himself in LA. But along the way, as we alluded to in part one, the famous summer night in 1959 in Omaha, Charlie is back in town briefly to settle his father's estate. His father Al had passed away and the Davises say, ah, we're now, we're investors with this local guy, Warren. We've told him about you.

• 20:12Ben Gilbert?

  Three years ago, we met him. He seemed like you.

• 20:15David Rosenthal?

  Let's set up a dinner and you guys can, we'll introduce you. You guys can meet. Both Warren and Charlie, I think are skeptical going into this dinner, but the legend goes that they all sit down to dinner and it's like electric. Warren and Charlie hit it off right away, which I think is true. And then the legend goes that at this dinner, Charlie starts laughing at one of his own jokes so hard that he actually rolls out of his chair onto the floor and starts rolling around on the floor. Now that is not true, but it did happen later that week because Warren and Charlie got dinner together like every night that week after that.

• 20:54Ben Gilbert?

  Oh, wow.

• 20:54David Rosenthal?

  That they were there. And yes, apparently Charlie did actually start rolling on the floor of a restaurant at one of his own jokes.

• 21:02Ben Gilbert?

  Which is the first of like many, like pretty funny quips about Charlie at dinner parties and his eating habits and his mildly self-absorbedness when it comes to these things.

• 21:15Ben Gilbert?

  There's another good one where he's been known to, as he's telling a story or opining on something, sometimes of course, like he'll need to drink water. So as he sort of takes his glass and puts it up to his, his mouth, he puts his hand out to stop anybody else from talking and holds his hands up until he's done taking a sip and then moves his hand out so he can finish telling the story. Like this is a man that loves to talk. It doesn't come out as much in Berkshire meetings until you sort of get him going. But yes, in social situations, he is the center.

• 21:45David Rosenthal?

  It's so funny because if you just watch the annual meetings, you would think that Charlie is the silent partner. Nothing could be farther from the truth. So during this dinner, Warren and Charlie are like enraptured with each other. And as they go along, Charlie's getting more and more puzzled because all Warren is talking about is businesses, companies and investing. And Charlie loves this. He thinks this is great, but. It wouldn't even cross any normal person's mind that this could be your job at this point in time. Like we talked about in part one, like maybe a couple of people in New York, maybe Ben Graham could do this. But the idea that somebody in Omaha, even somebody in LA

• 22:26David Rosenthal?

  could do this as their full-time job. Only Warren was thinking this way at the time. So eventually Charlie asked Warren, well, what do you do exactly for a living? And Buffett's like, well, you know, I have these various vehicles, these various partnership vehicles. Because at this point, he hadn't consolidated them all yet. These are all, he has like seven or eight different partnerships that he invests from.

• 22:51Ben Gilbert?

  And mind you, the setup is there's no fees. He's not drawing a salary from any of these.

• 22:55David Rosenthal?

  Yep. He's just working out of his spare bedroom at the house in Omaha, living off of his, what was it, $175,000 that he had when he left Graham Newman. So Charlie, though, this strikes him as brilliant. And he's like, he looks at Warren dead serious for once. And he says, do you think I could do something like that out in California? And supposedly Warren, as chronicled, sits there and he thinks for a minute. Because you know, Warren is, you know, he's very polite, but like, he's also, especially with people he respects, you know, very honest and direct. And, you know, he doesn't think many people can do this. But he thinks and he says, you know, yeah, I'm quite sure you

• 23:38David Rosenthal?

  could do this. And Charlie, you know, it changes his life, this dinner. He goes back to LA. He keeps practicing law. He's not ready to go all in yet on investing. But he raises some money. He starts a partnership. And he starts emulating Warren investing on his own out in Los Angeles. Suzy Buffett, who is at the dinner, although a silent participant, says in a quote in The Snowball, she says, I think Warren felt that Charlie was the smartest person he'd ever met. And Charlie felt that Warren was the smartest person that he'd ever met. And for the two of them, that was quite the high compliment. So.

• 24:16David Rosenthal?

  Munger goes back to LA. He starts investing. He also leaves the law firm that he was at and starts a new law partnership, which was originally called Munger, Toll's and Hills, later becomes Munger, Toll's and Olson, which to this very day, does all of Berkshire's legal work and will become very instrumental in the story at the end, as we shall see here. But he doesn't stay there long. He only stays at this new firm that he starts for three years. And then in 1965, he's doing so well investing that with Warren's encouragement, he actually leaves MTO and just like Warren, becomes full time running his partnerships, investing.

• 24:59Ben Gilbert?

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

• 25:05David Rosenthal?

  Still MTO today. Yep.

• 25:07Ben Gilbert?

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

• 25:21David Rosenthal?

  And your name first.

• 25:23Ben Gilbert?

  Right. It's wild.

• 25:25David Rosenthal?

  Totally wild. So Charlie starts out in his sort of investing style, doing the cigar butts and the like, and he's talking to Buffett all the time. They're always on the phone. He's absorbing all the Ben Graham philosophy. But it quickly becomes clear that he's wired a different way. So he starts saying to Warren and some of their other friends, this line that is sort of puzzling to them. Charlie says, you know, I really, I just like great businesses. And that's like not computing with Warren and the rest of the crew.

• 26:00Ben Gilbert?

  And Warren's like, you mean mispriced assets? Or because that's what we're doing here. We're buying mispriced assets. And when you say great businesses, you know, what do you mean by that?

• 26:09David Rosenthal?

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

• 26:28David Rosenthal?

  So the story goes that what really gets him down this line of thinking is at one point, he invests in a Caterpillar tractor dealership in Southern California. And this becomes a total albatross because the problem was as the dealership, you got to buy the tractors from Caterpillar upfront, which costs a lot of money. And then they don't turn over that fast. They're just sitting on the lot. And then every time one goes out the door, you got to put more capital up to buy a new one. It's like incredibly capital intensive. It's always tying, tying up capital. And if you want to grow, you want to add new stores, you got to invest in all the inventory upfront.

• 27:08David Rosenthal?

  And so Charlie, ever the rationalist, he realizes that like, hey, wait a minute. The goal of owning a business should actually be, one, that the business spits out more cash than it consumes. And ideally too, that it consumes as little cash as possible.

• 27:25Ben Gilbert?

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

• 27:33David Rosenthal?

  He's like, I want to give you cash once and very little of it. And then I want you to give me a lot more cash over time with me never giving you anymore.

• 27:42Ben Gilbert?

  This is best paraphrased in the line from Poor Charlie's Almanac, which was an awesome source, which is a better business. And it postulates, there are two kinds of businesses. The first earns 12% and you can take the profits out at the end of the year. The second earns 12%, but all the excess cash must get reinvested. There's never any cash. It reminds me of the guy who sells construction equipment. He looks at his used machines, take it in as customers bought the new ones and says, there's all my profit rusting in my yard. We hate that kind of business.

• 28:15David Rosenthal?

  Totally. So, all right, Charlie's starting to think about this and then he starts really going down the rabbit hole. He's like, well, what, how can you like achieve such a state in business? And that leads him to think about this idea of competitive advantage. Like this is all like, probably seeming like duh, normal stuff to everyone now, but like nobody is thinking this way at the time. And what is competitive advantage? It's, it's almost like a moat. It's like if your business is a castle, you have a moat around your castle so that nobody can attack it. It's a, it's a reason why competitors can't come and arbitrage your differential profits. So it kind of sounds like Hamilton, Helmer and Powers. So Warren and Charlie are spending a lot of time together.

• 28:57David Rosenthal?

  Famously, Warren and Suzy start vacationing in Southern California just so that Warren and Charlie can talk for hours. And when they come out, Warren's already a millionaire at this point. The family stays in a motel on Santa Monica Boulevard and then commutes over, drives over to Pasadena. Of course. So, one, they're hanging out because they respect each other's intelligence. But two, Alice points out in the snowball, there's, there's actually a second reason why Warren likes Charlie so much. And that's that as Warren's starting to get more and more known in Omaha and, and on the national scene for his investing track record, nobody's willing to tell him he's wrong anymore. Everybody's super deferential to him.

• 29:40David Rosenthal?

  And as Alice puts it, Charlie's deference to Warren was limited by his high opinion of himself.

• 29:50Ben Gilbert?

  That's awesome. And that is something that we start to see play out here in the late 60s where, you know, Buffett was famously very shy about ever sharing investment ideas. I think like occasionally at that annual group that he would convene of all the Ben Graham disciples, his fellow classmates, which he then started bringing Charlie into, that they would occasionally sort of allude to some investing ideas they were thinking about. You know, maybe this business is interesting, but they would kind of talk around it. Warren really found in Charlie someone that he could literally present, here's the name that I'm thinking about and start talking through the business and look for sort of holes in his thinking in a way that he never opened up to anyone else to ever say the name of a company he was thinking about buying.

• 30:36David Rosenthal?

  Yep, totally. That brings us back to, at the same time, Charlie's starting to go down this different path in philosophy. And Munger starts saying, and he says to Buffett, he's like, hey, you're like obsessed with this Graham guy. And like, I'll give it to you that that's a great strategy. It works. He met Graham at several points. This time Graham also lives in Southern California by now. But he's like, hey, he's not God. And there's a flaw in the cigar butt thinking, which is that it was driven by the environment that Graham came of age in, in the depression. And the quote from Charlie is that the flaw is that Graham believes that

• 31:17David Rosenthal?

  the future is more fraught with hazard than ripe with opportunity. And, you know, here in the post-war era in the US, especially in California, it's super hard to look out at the future and not see opportunity. So Charlie starts haranguing Warren about this. He says, it's a great quote, "Because Warren is so good at explaining Ben Graham, he's behaving like the old Civil War veteran, who after a few minutes of ordinary conversation always interjects, 'That reminds me of the Battle of Gettysburg.'" In other words, Warren is falling victim to one of the oldest human misjudgment tendencies in the book, the man with a hammer syndrome.

• 31:59Ben Gilbert?

  And what's that like when you have a hammer, everything looks like a nail?

• 32:03David Rosenthal?

  Exactly. So eventually Charlie does start breaking through to Warren. Right around this time, as Warren is shutting down the partnership, he's so, you know, he's so depressed, he's worried about the market, he doesn't see opportunity ahead, he only sees hazard. But at heart, though, Warren is an optimist.

• 32:26Ben Gilbert?

  Yeah, it's interesting. When you're 95% aligned with your teacher, it's easy to just try and do things exclusively their way. And it's only when you start really feeling yourself and feeling your, your legs under you a little bit, can you start saying, wait a minute, I am a little bit different and I can act, you know, as completely my own agent, rather than following their playbook.

• 32:47David Rosenthal?

  All right. So this leads us to the first big thing that Warren and Charlie do together, which is blue chip stamps. And I remember I used to, when I used to hear Warren and Charlie talk about blue chip stamps company, I thought this was like a quaint, like stamp collecting store franchise, you know?

• 33:04Ben Gilbert?

  I assumed that too. Yeah.

• 33:05David Rosenthal?

  Exactly. Like a baseball card shop or something? No, this is totally not what this was. So this is some like wild Americana history.

• 33:13Ben Gilbert?

  And when we say the first thing they do together, we should be crystal clear here. They are not Warren and Charlie on a stage the way that you see them today. There is Charlie, who is doing Charlie's partnerships and Warren, who's doing Warren's partnerships.

• 33:27David Rosenthal?

  Yep. So what is blue chip stamps? So around the turn of the century, the turn of the 20th century, department stores used to hand out, this is crazy. They used to hand out stamps as like a bonus incentive for customers to pay cash for goods instead of buying on credit. So the idea was if you bought something with cash, the store then handed you a certain number of stamps, which you could paste into a booklet. And when you filled up the booklet, you could exchange it for like prizes, like redeem it for like a, you know, I don't know, like furniture or jewelry, or like a bike for the kids or something like that.

• 34:09Ben Gilbert?

  They, they did want to incentivize paying with cash because cash flow.

• 34:13David Rosenthal?

  Exactly. So this was a way to incentivize paying with cash. So somebody had a brilliant idea that it would be better if you actually operated the stamp service as a separate business from anyone's store, so that customers can get stamps from lots of stores and then like aggregate them, get lots of stamps and then redeem them for, you know, more prizes.

• 34:39Ben Gilbert?

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

• 34:43David Rosenthal?

  Totally. But this business turned out to have two extremely attractive qualities. One, it had float. So the stamps companies that were running the stamp operation, the businesses, the stores, they bought stamps in advance from the stamp company. So like you're a department store, you're like, I'm going to buy $500,000 worth of stamps that I'm then going to give out to my customers over time to incentivize them. And they, they buy it at a discount.

• 35:16Ben Gilbert?

  So you better keep those in a safe because those are like cash.

• 35:19David Rosenthal?

  Yeah, exactly. And then the, they would give money, give US dollars to the stamp company in exchange for the stamps. And then the customers, you know, they would of the store, they would get the stamps and then they would redeem them. There'd be breakage, you know, it could be years from the time the stamp company sold the roll of stamps to the store.

• 35:36Ben Gilbert?

  Sounds like an insurance company.

• 35:38David Rosenthal?

  Exactly. Exactly. So there's float.

• 35:41David Rosenthal?

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

• 35:48Ben Gilbert?

  Right.

• 35:48David Rosenthal?

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

• 36:04Ben Gilbert?

  Right, right. So yeah, consumers want more stores to support it. Stores want more consumers to use it. Yeah, makes total sense.

• 36:12David Rosenthal?

  So by the middle of the century, there is one dominant national player in the stamp business, the SNH Green Stamps, except in California, where a bunch of stores had banded together and shut out SNH and launched their own stamp, the Blue Chip Stamp Company.

• 36:33Ben Gilbert?

  Amazing.

• 36:34David Rosenthal?

  Unbelievable. I had no idea about any of this. So in 1963, SNH and the Department of Justice both sue Blue Chip for monopolistic practices. SNH is trying to get into California and recruits the DOJ. Why the DOJ wasn't like, hey, SNH, you're a monopoly too. But anyway, regulatory capture, I guess.

• 36:58Ben Gilbert?

  Yep.

• 36:59David Rosenthal?

  So the stock gets pummeled when these lawsuits happen. But Munger's heard about this in LA and he tells Buffett and also their friend, Rick Garen, who's part of the Graham Group, which becomes the Buffett Group. Remember Munger's like a highly, highly experienced, top-notch lawyer, corporate lawyer. He says, what's going to happen here is Blue Chip itself is going to be fine. But the government, what they'll do, what the DOJ will do, they're going to force all of the California store chains that collectively own Blue Chip to divest it.

• 37:35Ben Gilbert?

  Hmm.

• 37:36David Rosenthal?

  And who better to buy it than us?

• 37:40Ben Gilbert?

  Huh.

• 37:41David Rosenthal?

  So indeed, that is what happens. In 1968, Blue Chip agrees to a consent decree with the DOJ, where the stores have to sell off 45% of the company. And boom, combination of Munger, Garen and Buffett all snap up 45-ish percent in Blue Chip.

• 38:01Ben Gilbert?

  And of course, like this sounds complicated to me because each of them represent a different shareholder base. They're sort of talking to each other. It feels like something could be fishy there.

• 38:13David Rosenthal?

  It could be. It could be. As the line we shall see in a minute is there's gotta be an indictment in there somewhere. Okay, so now we're in 1970. Warren has just unwound his partnership and distributed out shares of Berkshire, diversified retailing, which was a JV essentially that he had with Munger's partnership to invest in department stores, ill fated idea, and then blue chip. And remember Warren told his partners in the letter where he said he announced that he was winding down the partnership, that he intended to buy more of all of these companies. Well, he does.

• 38:53Ben Gilbert?

  And so just to be super crisp here, Warren owns some Berkshire, but Charlie doesn't own any Berkshire at this point. This is 1970.

• 39:01David Rosenthal?

  I think none at this point.

• 39:02Ben Gilbert?

  They've created the JV of diversified. They're definitely in that together and they both sort of share this idea about blue chip. So they both are big holders of blue chip as well.

• 39:11David Rosenthal?

  Yep. So after Warren winds down the partnership, he buys so much stock in these three companies from his former partners that his ownership of Berkshire doubles from 18% to 36%. His ownership of diversified doubles from 20% to 39%. And he buys so much blue chip that he goes from 2% to 13% ownership in blue chip, just personally. So Susie's like, oh no, second retirement is going to look exactly like the first retirement here.

• 39:46Ben Gilbert?

  And this really was the case, right? He was like, I'm winding down my partnerships. I'm done. What was the line? Something about his style and sensibilities no longer being suited to the current environment. And yet here he is heavying up on these three stocks.

• 39:58David Rosenthal?

  Yep. So Warren isn't the only one buying these stocks.

• 40:05David Rosenthal?

  Berkshire itself starts buying Blue Chip. So pretty soon Berkshire, Warren owns 13% of Blue Chip. Berkshire holds 17% of Blue Chip. Diversified owns 16% of Blue Chip. And Munger's partnership on his own owns 8% and Garin owns 5%. So 60% of Blue Chip is owned by these six different entities, all of which also own stock in each other.

• 40:37Ben Gilbert?

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

• 40:53David Rosenthal?

  Which we will get to in one sec. But ironically, while they're doing all of this buying, they're just so like thrilled at the prospects of what they're doing. The actual business of Blue Chip enters a major secular decline. So during the decade of the 1970s, Blue Chip's core business, even though they settled the DOJ suit, the core business declines 90% over the decade because consumers are just not that interested in stamps anymore. Credit cards are becoming a thing. It seems like an outdated kind of thing. So the business is declining.

• 41:31Ben Gilbert?

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

• 41:39David Rosenthal?

  I think the other part of it is the float. So just like Berkshire, Blue Chip is declining in its core business, but it's still got this super attractive float dynamic.

• 41:51Ben Gilbert?

  And if they don't own it outright, like, why is that attractive? Because they can't use that, they can't take the cash out from the float to use it for something else, right?

• 41:59David Rosenthal?

  Right, right. They can't take the cash out of Blue Chip, but they can redeploy it within Blue Chip.

• 42:06Ben Gilbert?

  Hmm.

• 42:07David Rosenthal?

  So they say, hey, let's run the Berkshire playbook that Warren, you just did with Berkshire. Let's start looking for other operating businesses to go buy with our float here at Blue Chip. So they tell Blue Chip's president, a guy named Bill Ramsey, to start looking about for, for companies to acquire. And one day in 1971, he calls Warren and Charlie and he's like, hey. I've got a, I've got a pretty interesting acquisition target here. It's a small, little family company here in LA called Sees Candy. And so Warren and Charlie come in, they start looking at the company and it's actually pretty interesting.

• 42:47David Rosenthal?

  So Sees, people love it, it becomes wildly popular across California, starts expanding. They develop a slogan that they want to be known for Sees quality, which is supposed to be even better than top quality. You've got like high quality, top quality and then Sees quality. It's so ubiquitous in California that, you know, the famous I love Lucy episode where-

• 43:11Ben Gilbert?

  Already know.

• 43:13David Rosenthal?

  Oh, you definitely know this. It's like one of the most famous moments in television in the 50s where Lucy and Ethel are working in the chocolate factory. And they're on the production line, they're supposed to like wrap the chocolates as they go by. And the chocolates start going so fast that they can't keep up and they're like stuffing the chocolate all like in their clothes.

• 43:30Ben Gilbert?

  Oh, I do know what you're talking about. Yeah.

• 43:32David Rosenthal?

  Yeah, it's, it's amazing. It was modeled after a Sees candy factory. So the problem with Sees though, from Warren and Charlie's perspective is it is decidedly not a cigar bud. So the factory and the stores and the hard assets on the books are valued at $5 million. But Sees already has an offer on the table for $30 million. So this like fails every Ben Graham test in the book.

• 44:01Ben Gilbert?

  It's so crazy to me, this like notion of cigar butts that like you're trying to pay less than literally just the property plan and equipment effectively. And like, we're not even talking about, you know, profit multiples here. We're literally just talking about like, well, are they asking you to pay more than the liquid value of all their assets? And like, oh no, six times the property plan and equipment. Ah, too far afield for me.

• 44:25David Rosenthal?

  But this is where, remember we were talking about Charlie's starting to get this tingling about great businesses and he's influencing Warren. He's like, hey, Warren.

• 44:36David Rosenthal?

  Let's actually look at the revenue and like earnings side of the equation here. This company is doing $4 million in annual pre-tax profit, and that's growing at 12% per year without putting any more capital into the business. Like this is, it might actually be worth paying this price.

• 44:56Ben Gilbert?

  So then what? That's about 8X trailing 12 months profit multiple.

• 45:01David Rosenthal?

  Totally. I mean, imagine that.

• 45:03Ben Gilbert?

  That's the offer.

• 45:04David Rosenthal?

  That's the offer, right, on the table. So Warren, of course, he hemps and haws about it and he's like, ah, I can't do 30, but we could offer 25 million. And the only reason he justifies it to himself at this point is he thinks, well, they probably have pricing power because people love the candy so much. So if we raise the prices, maybe I can get comfortable with this.

• 45:26Ben Gilbert?

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

• 45:33David Rosenthal?

  Yep, he's starting to come around. So they do get the deal done with the family. Blue Chip buys Sees for $25 million. And over the ensuing years, this little candy company delivers over $2 billion in free cash flow to first Blue Chip. And then when it would get absorbed into Berkshire Hathaway for a purchase price of 25 million. This is the first time that this concept of a wonderful business at a fair price versus a fair business at a wonderful price is executed by Warren and with Charlie's influence.

• 46:13David Rosenthal?

  And Warren, after a brief period of time of seeing the Sees operating results, becomes a total convert. So he would say later about this idea that it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price. He says, Charlie understood this early. I was a slow learner.

• 46:32Ben Gilbert?

  Love it.

• 46:33David Rosenthal?

  Meanwhile, Charlie is also learning from Warren that managing other people's money maybe isn't so great. So Charlie's partnership before 1971, 72 had done not quite Buffett levels of performance, but generated 28.3% IRRs for the first decade, which is still fabulous performance.

• 46:55Ben Gilbert?

  But not as steady as Warren. That's the thing to notice about Charlie. He did lose money some years.

• 47:01David Rosenthal?

  He did. So he had some real big years and some down years. And then in 73 and 74, Charlie's partnership falls 31.9% and then 31.5%. And this is super scarring for Charlie. He feels like he's got to like, if he can get, almost like Warren and his sister, been the first stock he bought back in the day. He's like, if I can get the partnership level back to roughly what it was, I'm going to work like hell to do that, but then I'm out. So he does that in 75. He returns 73.2% on the partnership in 75. And then he winds it down. He's out. He says, you know what? Warren's having a good time with this Berkshire

• 47:46David Rosenthal?

  model. I'm going to do the same thing here with Bleachip.

• 47:49Ben Gilbert?

  Yep. And the difference being, you know, Charlie was still running other people's money at that point. And I think he was doing a more traditional model, management fees and effectively carried interest or some kind of promote that he was getting above some certain hurdle. But, you know, in that business, when you're losing money, you feel it really hard because you're being judged on that performance. Whereas with Warren, the only other stakeholders that he had to think about were the, the other shareholders in those businesses. But Warren had made no promise to them of, I'm going to be effective with your capital. It was, you know, the structure was, look, I'm invested in this company, this C corp, you're invested in this company, this C corp, like. You can get out at any time. I'm not managing your money for you.

• 48:32Ben Gilbert?

  And so he just has all this. He is the weight off his shoulders. He can only lose his own money. There's no one else to be mad at him. And you know, if he does well, it's just for himself. But he's got a lot of money, so he can, he has the firepower of a lot of capital without it being other people's capital.

• 48:48David Rosenthal?

  Yep. And if the stock goes down, great. He might just buy more of the stock. Like, he doesn't need to feel terrible about it.

• 48:55Ben Gilbert?

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

• 48:58David Rosenthal?

  Right. He does want to make sure that Berkshire never goes out of business. That's incredibly important to him. But yeah, any given year's performance doesn't really matter. That's not how he looks at things anymore.

• 49:10Ben Gilbert?

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• 49:24David Rosenthal?

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• 49:38Ben Gilbert?

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• 49:48David Rosenthal?

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• 50:06Ben Gilbert?

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• 50:22David Rosenthal?

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• 50:39Ben Gilbert?

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• 50:48David Rosenthal?

  So if you're trying to turn AI ambition into real business outcomes and make it work safely, securely, at scale, go check out servicenow.com/acquired and tell them that Ben and David sent you.

• 50:59David Rosenthal?

  All right. In 1971, back when they were starting to look at C's Warren and Charlie for Blue Chip, Bill Ruane from the Sequoia Fund calls up Warren and says, hey, next time you're in New York, I want to set you up with one of my classmates from HBS, this guy that I really think you'll enjoy meeting. Why don't you get dinner with him? His name is Tom Murphy.

• 51:24Ben Gilbert?

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

• 51:28David Rosenthal?

  Yes, we've talked a lot about Tom Murphy, or Murph, as he was known and is known. He's still alive. I think he's 95.

• 51:37Ben Gilbert?

  Oh, awesome.

• 51:38David Rosenthal?

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

• 51:57Ben Gilbert?

  Yeah, I think that's right.

• 51:59David Rosenthal?

  ESPN, ABC, all the television stations, and they do it all with no further capital investment after that one TV station.

• 52:10Ben Gilbert?

  Unbelievable.

• 52:11David Rosenthal?

  With one very large and notable exception that we're going to talk about in a few minutes here. So they get together and Warren is immediately impressed with Murph and with Capital Cities. And he just loves everything about this business. And of course, he's already familiar with the media industries, intimately familiar with the newspaper industry. He knows a little bit about the, if not television, the sort of moving picture aspect of the media business because of maybe the second biggest investing mistake that he made after Intel, which we intentionally skipped over in part one to have the big reveal here. Ben,

• 52:55David Rosenthal?

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

• 53:06Ben Gilbert?

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

• 53:18David Rosenthal?

  Unbelievable. So yeah, I think it was, I think it was one year. So in 1966, Disney had been trading at an $80 million market cap, the Walt Disney Company at an $80 billion market cap. And it's not like Disney was much smaller back then. Like it was still freaking Walt Disney and it had the theme parks and everything. Mary Poppins had just came out and made $30 million at the box office and the stock went down because Wall Street was like, oh, well, movies, that's a hits driven business, you know, the next couple of years comps are going to be real tough after that Mary Poppins.

• 53:55Ben Gilbert?

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

• 54:02David Rosenthal?

  Yes, yes.

• 54:03Ben Gilbert?

  Unbelievable.

• 54:04David Rosenthal?

  Warren though, being smart, being Warren, he's like, wait a minute, it's Mary Poppins. They're going to be able to generate revenues for years after this. Like kids aren't only going to want to see Mary Poppins once and in one year. Every generation of kids is going to want to see this thing, have it take it out of the Disney Vault. So he values the company in his head just off Mary Poppins. He's like, the theme parks, all the other movies, let's assume all that's zero. That's my margin of safety. He thinks that it's still worth more than $80 million just on Mary Poppins. He puts $4 million of partnership capital into Disney, buys 5% of the company. And then of course, Warren being Warren at the time, within a year,

• 54:46David Rosenthal?

  he's made 2 million bucks on that. He's made a 50% return and he sells the whole thing.

• 54:51Ben Gilbert?

  My God. What's the quote, quote, better to be approximately right than precisely wrong? Like, sure, he was approximately right, but you have to stretch that approximately pretty far to be like, it was the right decision for you to get out of that business. I mean, okay, so the principle of that quote is, look, there's no way that you're going to be able to exactly know the intrinsic value of the company. So you will never know exactly what you should pay for it either on your entry price or your exit price. So, you know, it's the margin of safety idea that you should be approximately right. So if you can get a big margin of safety, then you're sort of okay on the entrance price and you're okay on the exit price, even if they're not precisely correct. Well, like, You were way, way off on what the intrinsic

• 55:36Ben Gilbert?

  value of this enterprise could be. And like, sure, you made money, but this is the sin of, I suppose it's omission because it's that he didn't continue to make money. In a way, it's commission because he actually had to act to sell the stock. But gosh, how, how different his net worth would be. And who knows about Berkshire's future, but if he had continued to hold 5% of Disney at that point.

• 55:59David Rosenthal?

  Totally. I mean, Geico, Amex, Disney, we're not even talking about Intel. These are all companies that Buffett owned like a meaningful percentage of in his very early days and didn't hang on to them.

• 56:12Ben Gilbert?

  No. All right. So he knows about the moving picture business from a little bit of Disney. So he's sitting down.

• 56:17David Rosenthal?

  He's sitting down with Murph.

• 56:18Ben Gilbert?

  He and Murph are hashing it out and Murph says to him, what?

• 56:21David Rosenthal?

  Murph says, after the dinner, Murph is so impressed with Warren's, you know, sort of like management investing mind, like these are two people cut from the same cloth. He decides that he wants Warren to join his board. So he flies out to Omaha. He makes a pilgrimage to go see Warren and he says, Hey, I really want you to join the Capital Cities board.

• 56:42Ben Gilbert?

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

• 56:45David Rosenthal?

  Yeah, exactly.

• 56:46Ben Gilbert?

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

• 56:55David Rosenthal?

  Love it. I think there's some famous story, didn't we tell on the ESPN episode about how they only painted the fronts of their buildings and not the sides in the back?

• 57:06Ben Gilbert?

  That sounds right, though.

• 57:07David Rosenthal?

  Amazing. So Warren's like, look, Tom, I love you and Dan, but honestly, the, the only way that I can join your board is if I were to own a, a large chunk of your company. And this is like an impasse because just like Warren, Tom equally feels like issuing stock is the ultimate sin and he refuses to do it. So they agree that they're just going to be friends. They will turn to each other for advice on their various businesses for the time being, but there's not going to be any, any formal relationship. It was also quite convenient of Warren to do this because he knew that the FCC

• 57:51David Rosenthal?

  rules were such that they would not let anybody be on the board of multiple different companies that owned television stations around the country. And Warren's got his eye on another company that owns some television stations, the Washington Post Company.

• 58:12Ben Gilbert?

  Ah, right. I didn't realize, I forgot they, they had gotten into TV at this point already.

• 58:17David Rosenthal?

  Yep, they had, they had. So his boyhood dream, his paper route, and the reason he's got his eye on the Post is they've just done a public offering.

• 58:29Ben Gilbert?

  And what, what year is this?

• 58:31David Rosenthal?

  This is 1971.

• 58:33Ben Gilbert?

  Seventy one. Okay. So still only like a year or two after he's wound down the partnership.

• 58:37David Rosenthal?

  He's still in retirement mode.

• 58:39Ben Gilbert?

  Here's a little early carve out too, for anyone who, who wants an unbelievably good sort of dramatic telling of that IPO and the events around it. Go, go watch the Post with, with Meryl Streep.

• 58:49David Rosenthal?

  The Post. Oh, it's so good. We definitely have to do a whole episode on the Washington Post Company at some point, but suffice to say for now that the story is equally, if not more amazing than the New York Times Company. The short version of it is that heading into the IPO, the Post has been in the Meyer slash Graham family for 40 some odd years at this point. The CEO of the Post, but not the chairman, the CEO is a woman named Catherine Graham, who her story is just, probably many folks have heard of her, is just amazing. Watch the Post and we will tell it someday, but she assumes the role

• 59:31David Rosenthal?

  of publisher and CEO at age 46 with four children, having never worked a job in her life and goes on to become one of the greatest CEOs in American history, you know, sees the paper through the Pentagon Papers, through the Watergate scandal, grows the value of the company enormously. She was one of the CEOs that Will Thorne Dig profiles in, in the outside book. So great. So Warren sees all this from the outside. He's got the attachment to the Post. The IPO is happening and he says, This is gonna be my, my opportunity to come back. So he reaches out to her initially with an idea. He wants to tread carefully.

• 1:00:14David Rosenthal?

  He's very respectful of Kay and the Graham family and what they've built. He also knows that it's a dual class share structure. So they have control. Like there's no, no matter how much stock he buys, like there's no, all the decisions in the company are getting made by the Graham family, just like at the New York Times. So he reaches out with an idea and says, I've heard that the New Yorker, the magazine is for sale. Would you be interested in maybe doing a 50 50 bid JV to buy it together?

• 1:00:50Ben Gilbert?

  And she has no interest in that, right?

• 1:00:51David Rosenthal?

  Yeah, she has to, she's like, I'm learning how to be a CEO here. We're taking the company public. The Pentagon Papers are happening. No, very, very nice to meet you, Mr. Buffett from Omaha, but thanks, but no thanks. But Warren's like, it's like, I've, I've gotten to know her. I've, I've got my foot in the door. Two years later, the person who was chairman of the Washington Post company, Fritz Beebe, who I believe was a long time family lawyer of the Myers and the Grahams. He dies and his estate is being liquidated, of which there's a lot of Post stock in it. And Warren arranges to buy a 50,000 share block from the estate.

• 1:01:37David Rosenthal?

  And

• 1:01:38Ben Gilbert?

  Which, you know, has to, has to feel underhanded, right? Like if you're the Graham family, you're like, sorry, wait, who's buying what?

• 1:01:44David Rosenthal?

  Yeah, who, what, this guy at Omaha? And he'd also been buying on the open market too. And he now owns 5% of the company. So when he's having dinner with Murph, he's like, He's already got his, his plans in motion here. So he writes Kay a letter. Remember they've already met. He says, this purchase represents a sizable commitment to us, being Berkshire, and an explicitly quantified compliment to the Post as a business enterprise and to you as its chief executive. Writing a check separates conviction from conversation. I recognize that the Post is Graham controlled and Graham managed, and that suits me fine.

• 1:02:25Ben Gilbert?

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

• 1:02:36David Rosenthal?

  Exactly. He wants to be a partner to great managers and stewards of generational businesses. Kay, nevertheless, probably rightly is a little spooked.

• 1:02:50Ben Gilbert?

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

• 1:02:56David Rosenthal?

  Yep. And you're so great that it suits me fine that you control it.

• 1:03:01Ben Gilbert?

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

• 1:03:07David Rosenthal?

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

• 1:03:12Ben Gilbert?

  Yep.

• 1:03:13David Rosenthal?

  So she agrees to meet with him briefly when she's out in Los Angeles and Warren's thrilled. She shows up at the meeting famously looking like Kay. She's Kay Graham. She's like one of the most prominent.

• 1:03:27Ben Gilbert?

  Stately.

• 1:03:28David Rosenthal?

  Stately, one of the most prominent people in the Washington social scene. She's probably the most powerful woman in America at this point in time.

• 1:03:35Ben Gilbert?

  Hanging out with presidents. Yeah.

• 1:03:37David Rosenthal?

  First name basis with, yes, everybody in Washington. And Warren shows up looking like, you know, the bedraggled, wrong sized suit, you know, guy from Omaha, from the hills.

• 1:03:51David Rosenthal?

  And she thinks this is just hilarious. They hit it off right away in this second meeting. And she says, you know what? Maybe this Warren guy isn't so bad. Why don't you come back out, meet with me again in Washington? So he comes back out to Washington, shows up right in the middle of the Watergate proceedings where Kay and her publisher Ben Bradley had pulled an all nighter the night before, making decisions about what to publish about Watergate. But she still makes time for him. They go out to lunch and then afterward Buffett presents her with a contract that he's had drawn up that legally binds him and Berkshire, that

• 1:04:32David Rosenthal?

  they will never buy another share of the Post without the Graham family's permission. By the way, by that time, Warren already owns 12% of the company because he's kept buying.

• 1:04:44Ben Gilbert?

  In exchange for what? Like, why would he say, just we voluntarily?

• 1:04:48David Rosenthal?

  Not in exchange for any, he just, he just really wants to be on Kay's good side and he, he really, really wants to be on the Washington Post board. And so he's kind of presenting, I think he uses the term, he invokes Little Red Riding Hood and the wolf, he says, you know, I may look like the big bad wolf, but we're going to take the fangs right out of the wolf. I'm never gonna buy another share without your agreement. I've had this contract drawn up. It's kind of funny, but Kay loves it. And they seal the deal. She says, well, okay then, you know, I'll start calling you for advice. And what Warren really wanted her to say was, why don't you join the board then as a 12% owner of the company? But she doesn't. Warren desperately wants to get on the board.

• 1:05:32Ben Gilbert?

  And why does he want to get on the, is it an emotional thing? Or is it, we haven't talked about why Warren views a paper like this as such an incredible business? Is it worth taking a moment on that?

• 1:05:45David Rosenthal?

  I think the board thing specifically is probably an emotional thing, but the paper, yeah, at this point, it's not only the dominant paper in Washington, but it's the, you know, one of the foremost publications in the country, if not the world, after the Pentagon Papers and the Watergate scandal.

• 1:06:09Ben Gilbert?

  So it both has that franchise effect in Washington. I mean, it is the paper for that city, which I think this comes from a little bit of a different story with the Buffalo Evening News, which I don't think we'll get to today. But Buffett famously referred to being the only paper in town, or the biggest paper in town, as an unregulated toll booth that you have, where you basically have pricing power and everybody's going to subscribe to the newspaper. So, you know, it's a, it's a license to print money. So there's definitely his notion of a franchise town newspaper is awesome. This is one of the ones in the most important town in America, and now it has this national, international reach, not to mention all of the sort of great characteristics of a media business,

• 1:06:52Ben Gilbert?

  where you create the content once, and then it's infinitely replicatable. And of course, there's delivery costs, but it's a freaking good business that's wonderfully defensible.

• 1:06:59David Rosenthal?

  Yeah. And I think specifically on that defensibility of the newspaper part of the business at the time, and the winner take all network effect in any given geography, is that if you're able to amass enough readers, it's just like the stamps business, then the advertisers want to be where the majority of the readers are. And once you get the ad dollars flowing in from the advertisers, then you can offer deals. It's like, it's like the group buying clones in, in China. You can offer subscription deals to enough subscribers to grow your subscriber base, that you can crowd out all the competition,

• 1:07:40David Rosenthal?

  and the market just naturally tips to a single player. And that's happening in Washington, a large city. So this is a fantastic newspaper franchise.

• 1:07:52Ben Gilbert?

  All right. So he's built himself a 12% position. He really likes the company. He wants to get on the board, but he's not on the board.

• 1:07:58David Rosenthal?

  He's not on the board. What happens next is like a middle school dance. It's hilarious. So he doesn't have the courage to say to Kay in the meeting,

• 1:08:08David Rosenthal?

  Well, hey, I'd really like to join the board and I presented you with this contract. Instead, he calls up Murph and he says, you know, gosh, Murph, I really wanna, wanna join the, the board of the Washington Post, but Kay doesn't seem to be getting the message. Do you think you could go see her and, you know, tell her what, how great a guy I am and, you know, that, that I'm really not so bad. And, and I really do want to join the board if she would just ask me. Wow. So Murphy, Tom goes to CK and tells her and she's like, oh my, well, yeah. Um, I guess it would be nice to have him on the board. I really respect him. Well,

• 1:08:51David Rosenthal?

  but I can't really just send him a letter and ask him like, he should really ask me.

• 1:08:58David Rosenthal?

  So Warren is like, I'm gonna invite Kay out to, by this point in time, he and Suzie have a house in Emerald Bay in Laguna Beach in, in Orange County in California. I'm gonna invite Kay out to a weekend at the, the family house in, in California. And I'm gonna be like, it's gonna be perfect. I'm gonna host Kay to socially make it perfect for her. And, you know, at the end of the weekend, then I'm gonna make the ask to join the board. So he's really putting on a show for Kay. She comes out, she's a little puzzled. The whole weekend goes by, he doesn't ask, he doesn't ask. And then on Sunday morning, Kay finally turns to Warren and says, so I hear you want to join the board.

• 1:09:45David Rosenthal?

  But I'm not sure, you know, I'm waiting for the right time to do it, to bring it to my other board members. And supposedly Warren, you know, looks at her with longing eyes and says, Kay, when is the right time then?

• 1:09:59David Rosenthal?

  And they fall into each other's arms and she says, I'll join my board. And this is the beginning of a immense friendship between them. They become incredibly close for the rest of Kay's life. They go to events together. They spend weeks at a time together in each other's houses, in each other's apartments in various cities. It's never been written, whether this relationship was purely platonic or also romantic.

• 1:10:28David Rosenthal?

  Unsure, but it certainly becomes a amazing relationship. Warren would stay on the board of the Post for most of the next 37 years.

• 1:10:40Ben Gilbert?

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

• 1:10:42David Rosenthal?

  Yep. So the 12% stake that Buffett bought for Berkshire cost $10 million and in 2014, to put a bow on the Post investment, Berkshire sells its stake in what is then Graham Holdings, all the rest of the Washington Post businesses after Bezos buys the Post itself. Berkshire sells its stake for $1.1 billion, which is only a 12% IRR from the initial $10 million investment. However, the Post had also been paying dividends all throughout those

• 1:11:20Ben Gilbert?

  Oh, wow.

• 1:11:22David Rosenthal?

  40, 50 years. So I don't have the data on

• 1:11:25Ben Gilbert?

  Total dividend return.

• 1:11:26David Rosenthal?

  Berkshire received in cash flow and dividends from the Post, but suffice to say, it was an excellent investment on Warren's part.

• 1:11:35Ben Gilbert?

  So 10 million for 1.2 billion?

• 1:11:37David Rosenthal?

  1.1.

• 1:11:38Ben Gilbert?

  1.1. Wow. By that point, it's funny, it's actually not a big holding for Berkshire relative to everything else they own by the time they Bezos buys the Post.

• 1:11:47David Rosenthal?

  Yeah. And, you know, Bezos ends up buying the Post, I think for 250 million.

• 1:11:52Ben Gilbert?

  Something like that.

• 1:11:53David Rosenthal?

  When that happens in 2014, 2013, 2014. Certainly the value of the Post during the heyday of the newspapers of the 90s and 2000s was much, much, much higher than that. And the cash flow that it was spitting off that and sending back to Berkshire and other shareholders was significant.

• 1:12:12Ben Gilbert?

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

• 1:12:20David Rosenthal?

  No, I didn't see that.

• 1:12:22Ben Gilbert?

  Yep.

• 1:12:22David Rosenthal?

  Amazing. Don, of course, being Kay's son, who would take over. I think he became CEO before her death and then, and then after her death became chairman and CEO.

• 1:12:30Ben Gilbert?

  Too funny. All right. So that's the Post. So let's reset a little bit on timeframe and sort of Warren's evolution here. Everything's not yet consolidated under Berkshire, right? Like who was accumulating the shares of the Post?

• 1:12:46David Rosenthal?

  So that was Berkshire.

• 1:12:48Ben Gilbert?

  Okay. But he's got this whole blue chip stamp thing going on.

• 1:12:51David Rosenthal?

  Yep. And diversified.

• 1:12:54David Rosenthal?

  And so we've been alluding to the hot water that they get into with the feds. So right as Charlie's closing down his partnership.

• 1:13:04Ben Gilbert?

  And this is like 75 ish?

• 1:13:06David Rosenthal?

  75, yep, in 75, he and Warren get a call from one of Charlie's former partners at MTO, Chuck Rickershauser, who had done the C's deal for them. And Chuck says, hey, guys, I just got off the phone with the SEC. And they're considering pressing charges against you for securities violations for this Russian doll, you know, version of corporate structure that you've got going on here. And he famously tells them Chuck would spend like weeks putting together a corporate flow chart of all these different entities and who owns what. Well, we'll try and link to an image of it in the show notes. It's amazing. There's so many different subsidiaries and subentities.

• 1:13:49David Rosenthal?

  And he looks at it and he says, there's got to be an indictment in here somewhere, guys. I don't know what you've been doing, but.

• 1:13:57Ben Gilbert?

  I remember reading this when, when I was doing the research and the Buffett image that you know of today, this sort of folksy, near benevolent, multi billionaire or multi-deca billionaire. I don't even know the right phrase for it would be 100 billionaire. If it wasn't donating so much to the Bill and Melinda Gates Foundation, that he was in hot water with the SEC. Like, it's just the last thing that I would have expected as sort of the Buffett novice before I started doing the research.

• 1:14:24David Rosenthal?

  It's still, when I was reading about this, I was picturing Warren and Charlie like Tupac in Picture Me Rollin' and the Fed or Allies want to see him dead.

• 1:14:33Ben Gilbert?

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

• 1:14:36David Rosenthal?

  You could never unsee that, but it's so apt. Literally the feds are like, I don't know what's going on here, but like. I don't like it.

• 1:14:46Ben Gilbert?

  Clue me in. It was something to do with the fact that they ended up paying more.

• 1:14:51David Rosenthal?

  Yeah.

• 1:14:51Ben Gilbert?

  For something when they could have actually paid less.

• 1:14:54David Rosenthal?

  My understanding is I think the feds had sort of been on the tail because Warren especially is, you know, now becoming so known. He's, he's, he's high profile, right? Like he's on the board of the Washington Post. Like how much more high profile with agencies in Washington can you get? So the investigation comes to center on a company called Wesco Financial that Blue Chip had bought after seize, they'd kept looking for other great businesses and that they'd bought a stake in Wesco.

• 1:15:24Ben Gilbert?

  And this some kind of bank? It's like a financial services business at this point?

• 1:15:27David Rosenthal?

  Yeah, it was, it was a financial services business in Southern California. And what happened was there was another company, I think like Santa Barbara Financial Corporation or something like that, Financial Corporation of Santa Barbara, that had a buyout offer for Wesco. And Warren and Charlie thought it was undervalued and had sort of stepped in and scuttled the merger and ended up investing through Blue Chip in Wesco instead. So there was still a stub kind of public.

• 1:15:58Ben Gilbert?

  They basically backstopped the price because they're like, look, we already, we hold a bunch of this already. We're not going to let you buy it for this really cheap per share price. So we're going to come in, we're going to lead another investment round effectively in it or buy some more of it at a higher price to make it so that like, you're not going to get away with this steal that you're, you're coming in.

• 1:16:15David Rosenthal?

  And so the way it goes down is they, through their work in convincing, you know, the board and the family that owned most of Wesco, they convince them to drop the merger. When the merger drops, the Wesco stock falls, of course. And that's when Warren and Charlie invest, but they feel bad about tanking the stock price. So they decide, they, they work out a deal with the company and with the family that they'll buy shares and invest. I can't remember if it was at the merger price or maybe even slightly above. And the feds are like, wait a minute, there's got to be something shady going on here because like,

• 1:16:59David Rosenthal?

  A, you scuttle the merger, B, you then. Could have just bought the stock for lower, but you paid this artificially high price. What's going on?

• 1:17:10Ben Gilbert?

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

• 1:17:19David Rosenthal?

  So they're very confused. So Warren ends up getting subpoenaed and testifies that they paid the price they did because, quote, "It was important how Wesco management feels about it." Now, you can say, "Well, we own the controlling interest, so it doesn't make any difference." But Lou Vincenzi, who was the president of Wesco, "He doesn't really need to work for us. If he felt that we were, you know, slobs or something, it just wouldn't work."

• 1:17:48David Rosenthal?

  And Munger, when he's testifying, he, of course, invokes who else but Ben Franklin? In his testimony, he says, "We didn't feel our obligation to the shareholders was inconsistent with leaning over backward to be fair. We have that Ben Franklin idea that the honest policy is the best policy. It had sort of a shoddy mental image to us to try to reduce the price."

• 1:18:15Ben Gilbert?

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

• 1:18:41David Rosenthal?

  Yep. And he's totally right. This is something I'd always wondered, you know, from afar, looking at Berkshire, they buy these companies that are, if not wholly family-owned businesses, many of them are public companies, but have a large family controlling ownership, like Wesco, like the, like the Post. They buy these companies and then the family or the current management often stays on and keeps working there. And I'm like, why would, why would they do that? And this is the key why, because they're not just trying to like, they're playing the long game. You know, they, what they really want is great managers who've built great companies to stay running them. And the way to do that isn't to, you know, negotiate every last dollar out of them.

• 1:19:24Ben Gilbert?

  Or even if it is like, I think some of, I think we're conflating two things here a little bit. I think Berkshire does make sure they get a great deal when they buy a family owned business outright. You know, they, they, they're good at buying low, but they either just believe that the business has so much future upside in it that they're, they're willing to, you know, meet in the middle on price, or they are very good at identifying managers who have a splinter in their mind to continue to do the work. Like there's something about, they're very good at this shrewdly evaluating, even if this person no longer holds a, a single share of their company, are they going to show up for work every day because this is their life's mission and purpose. And, uh, you know, I'm not totally,

• 1:20:06Ben Gilbert?

  I don't think that's what was going on in the, the West Coast financial situation, but I think when they buy these family owned businesses, there's a lot of that in the evaluation of the business.

• 1:20:14David Rosenthal?

  And they, they definitely compensate those managers well.

• 1:20:20Ben Gilbert?

  Yeah.

• 1:20:20David Rosenthal?

  For their continued performance. And I think that was like part of it here too, because it's almost like this is part of the upfront compensation is the price that they're going to pay.

• 1:20:29Ben Gilbert?

  Right.

• 1:20:30David Rosenthal?

  For the company.

• 1:20:31Ben Gilbert?

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

• 1:20:43David Rosenthal?

  Not to mention, it's not great for their reputation when they're going out trying to talk to the K grams of the world and saying, hey, no fangs here, when the SEC is investigating them. So they end up sort of coming to this gentleman's agreement with the feds where blue chip, which had, which had been the primary player in the West Coast saga, although I think Berkshire and maybe diversified, were also buying shares too.

• 1:21:08Ben Gilbert?

  Of course.

• 1:21:09David Rosenthal?

  Which was part of the problem, promises not to do it again, something like this.

• 1:21:15Ben Gilbert?

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

• 1:21:17David Rosenthal?

  We didn't, we won't admit that we did it, but if we did do it, we won't do it again. And most importantly, Warren and Charlie agree to start taking steps to, quote, "simplify this complicated rat's nest" structure of companies that they have. So, right off the bat, they finally merged Diversified into Berkshire, which they had wanted to anyway, and by this point, Diversified owns a large chunk of Berkshire shares. Charlie gets installed as the chairman of Wesco to be sort of more arms length than Warren, and they make it a gold, a merge, blue chip into Berkshire as soon as all of the remaining kind of legal suits wind up and settle here. That actually takes a while, but it finally

• 1:22:01David Rosenthal?

  does happen in 1983.

• 1:22:04Ben Gilbert?

  Wow, that really took a while, then.

• 1:22:06David Rosenthal?

  It really does take a while, yeah. I'm not sure exactly why, but especially since the SEC wants them to merge it all into one company.

• 1:22:14Ben Gilbert?

  Yeah.

• 1:22:14David Rosenthal?

  And Warren and Charlie want to as well. For whatever reason, it takes until 1983.

• 1:22:20Ben Gilbert?

  All right, so they're making an effort to clean things up. They've got this SEC thing behind them. It's the late 70s. There's another chapter on the horizon for Berkshire.

• 1:22:30David Rosenthal?

  Oh, oh, yes. Is there ever? And indeed, it is a chapter involving an old flame, the original crush of Warren's. This is like, I think this is the thing about Warren. You know, I don't know about his romantic life and situation. It's certainly also complicated. There's a lot about that in the snowball and elsewhere. Not the scope of our show to get into, but he certainly has like a serial love affairs with companies.

• 1:23:00Ben Gilbert?

  Well, and somehow, there's all these businesses that he has like a romantic flame for from his childhood and from various parts of his life that just so happened to be these like unbelievable businesses where like it's a furniture mart, or it's the soda he drank growing up, or it's the newspaper he delivered. And like investing in each and every one of those proves to be like a once in a generation unbelievable business. It's almost like Big Fish in a way, like this man's life is just surrounded with these like Six Sigma events of like these really crazy, or Forrest Gump, or like, what are the odds that the smartest guy that the army ever surveyed, or the air force ever surveyed in that generation IQ wise, happened

• 1:23:43Ben Gilbert?

  to also be born in Omaha and then get introduced to him by-

• 1:23:47David Rosenthal?

  Work at the grocery store.

• 1:23:48Ben Gilbert?

  It's just crazy. Yeah, work for his grandpa.

• 1:23:51David Rosenthal?

  Yeah. Well, it's also funny that like Warren and more Warren here than I think Charlie. He's so smart and so analytical. Like, you know, Charlie Munger thinks he's the smartest part. Warren is the smartest person he's ever met. That's saying something. At the same time, Warren is also so emotional and nostalgic and has this, I think you said it on the last episode, this sense of like, you know, what he looks for in companies and what he absolutely wants to be himself is like viewed as an artist painting a painting.

• 1:24:22Ben Gilbert?

  Mm hmm.

• 1:24:23David Rosenthal?

  So of course, we're talking here about Gecko.

• 1:24:27Ben Gilbert?

  All right, listeners. Now is a great time to talk about a new partner of ours here on Acquired, Logora, the agentic operating system that is redefining how the world's best legal teams work.

• 1:24:41David Rosenthal?

  Yep. It's sort of obvious that AI is going to completely change the legal industry. I bet most of you listening have dropped a contract into some sort of AI chatbot out there. Logora took that insight and asked the question, what if you really built something with that power from the ground up for the legal industry?

• 1:24:57Ben Gilbert?

  So the founders did exactly what great founders do, operate with obsessive customer focus. They embedded inside a massive law firm for months. They sat with the lawyers just watching how the work really gets done.

• 1:25:12David Rosenthal?

  And that's how you get features that customers love, like tabular review, where you drop in a folder of hundreds of contracts and it pulls every key term into a grid a lawyer can actually work with. Logora's bet here is interesting. Since it lets each lawyer handle more complexity, any given person can increase the quality of their work and do higher value work. And this means that the pie can grow even as each individual task takes less time.

• 1:25:36Ben Gilbert?

  And they recently launched Logora Agent, offering greater intelligence and performance. The agent lets lawyers set an objective, then it can handle the planning and the execution and delivery of the final product. Legal teams get to maintain full control and transparency since they're still involved where judgment is required.

• 1:25:55David Rosenthal?

  And Logora works where you already work. You can use it within Microsoft Word while redlining or drafting. The early Logora numbers essentially speak for themselves. When they have a head-to-head pilot with their top competitor, they win 70% of the time. Logora now has over 100,000 lawyers on the platform from 1,200 legal teams in 50 countries. And crazily, they went from 1 million to 100 million in ARR in about 18 months.

• 1:26:25Ben Gilbert?

  Truly insane numbers. And that is the real test. Plenty of things demo well, but the question is whether a busy associate actually reaches for it during crunch time, or whether a partner trusts it before going into a conversation with a major client. If your legal team wants to check it out, whether you're a law firm or you're in-house at a company, you can learn more at logora.com/acquired and just tell them that Ben and David sent you.

• 1:26:50David Rosenthal?

  In the intervening, at this point, it's like 20 years or so, two decades, since Buffett had tragically sold his Geico stake. The company grew immensely. It made the acquired like growth in its target market. When we went from just acquisitions to just to telling the story of all great companies.

• 1:27:12Ben Gilbert?

  It's like, where are you going there?

• 1:27:13David Rosenthal?

  When it moves beyond just targeting government employees to opening up to anybody. Non-government employees can also get their auto insurance through Geico. And this is huge. The problem, though, was that in chasing this growth in this new market, the tight underwriting and pricing of risk of all of these new customers didn't quite keep pace.

• 1:27:43Ben Gilbert?

  But uh.

• 1:27:44David Rosenthal?

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

• 1:27:59Ben Gilbert?

  It's a known data set. It's a pre-homogenous group and it's a lower risk homogenous group.

• 1:28:05David Rosenthal?

  Totally. So they didn't really update their pricing enough as they've broadened out to the rest of the population. And as we talked about last time, in insurance, there is never any such thing as a bad risk, but there is such a thing as a bad price. And the doubly compounding problem for an insurance company, when you've been mispricing your risk over many years, is that just like you get the amazing benefits of the float business model where you get the money upfront, you get to use the money before you need to pay out claims. When you misprice your risk, that whipsaws on you. Once you realize

• 1:28:47David Rosenthal?

  that you're going to be on the hook for a lot more dollars than you have capital available, you're in for a long period of pain because the premiums that you got, they're already in the bank. You can't go get more money from those customers, but you know that you're now facing years of streams in the future of more money that you're going to have to pay out than you have.

• 1:29:11Ben Gilbert?

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

• 1:29:23David Rosenthal?

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

• 1:29:32Ben Gilbert?

  Yeah. The analogy breaks down somewhere in here, but yeah.

• 1:29:35David Rosenthal?

  It's bad. Suffice to say, it's bad and it's not getting better anytime soon. So in 1976, the company announces a $190 million underwriting loss, the largest in its history, maybe even the largest in like auto insurance history, period, at that point in time. They eliminate the dividend for the company because they need to conserve all the cash that they can to deal with this. And Wall Street figures out they don't have enough capital to cover future losses. This is like a crisis situation. Insurance regulators descend on the company. The stock drops from $61 a share to $2 a share. Like, can you imagine that? You know, what's that like? 90% value destruction.

• 1:30:20Ben Gilbert?

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

• 1:30:23David Rosenthal?

  Totally. So Warren fortunately hasn't had all of the cigar butt Ben Graham, ironically Ben Graham with GEICO, a philosophy beaten out of him. This piques his interest again in GEICO. So he thinks he's found another, you know, Amex type of situation where.

• 1:30:39Ben Gilbert?

  Yeah. Like where's Buffett to say that they're going to recover from this? Then he's not going to, you know, catch the knife on the way down.

• 1:30:46David Rosenthal?

  Right. So he wants to find out, can this actually be turned around? But unlike the salad oil thing where it was pretty easy to figure out, like, yeah, this is going to be good. Like, that's not going to be the case here. There is no way to avoid the years of pain ahead that GEICO is going to go through. But there is something that Warren sees happening that the rest of the market doesn't quite understand yet, which is that GEICO, you know, a good move, fires all of its management team and brings in a new CEO.

• 1:31:23David Rosenthal?

  A grizzled, literally grizzled veteran of the insurance industry who Warren had heard about named Jack Byrne. And this guy is a legend.

• 1:31:34Ben Gilbert?

  And, and does Warren have anything to do with installing him or have?

• 1:31:37David Rosenthal?

  No, no, no, this is Warren's just watching from afar. He's waiting to see if there's something that like, a glimmer of hope that maybe GEICO could make it out of this because the stock is like super attractive. I mean, two bucks a share.

• 1:31:49Ben Gilbert?

  Right. So this is their current board, like figuring out what to do here.

• 1:31:53David Rosenthal?

  Yep. Yep. Partially at the, uh, shall we say, request of the regulators. So they're like, you, you guys have really gotten yourself, uh, up a creek here. So Jack had been one of the top execs at Travelers Insurance before he resigned in like a huff. When he was passed over for CEO.

• 1:32:14Ben Gilbert?

  Wow. That's going to come full circle.

• 1:32:16David Rosenthal?

  Totally. It's absolutely going to come full circle.

• 1:32:20Ben Gilbert?

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

• 1:32:26David Rosenthal?

  So Jack is like, he's the man for the job. He comes in and he engineers a plan to go out to all the other auto insurers in the industry. And basically argue to them like, hey, if GEICO goes under, yeah, you'll lose a competitor, but it's actually going to be terrible for you because like if we go bankrupt, all of these underwater policies, the regulators are going to make you guys absorb them. Like you don't want that.

• 1:32:54Ben Gilbert?

  Oh, man, was that true? Was that what would happen?

• 1:32:56David Rosenthal?

  Well, I mean, you can't operate a motor vehicle in America without car insurance. Like, so if your insurer goes under, you need insurance. And especially if you've got claims underway, like what's going to happen to those? Like if the insurance company behind those claims goes away.

• 1:33:13Ben Gilbert?

  Interesting.

• 1:33:13David Rosenthal?

  So this is the argument that Bern makes to the industry. And it mostly works. And the deal that he proposes is to get all these other auto insurers, not to buy GEICO, but to reinsure GEICO for some of these future losses off of their own balance sheets.

• 1:33:31Ben Gilbert?

  And remind us what reinsurance is.

• 1:33:33David Rosenthal?

  Well, so reinsurance is anytime an insurer is selling off some of their risk in their portfolio to another insurance organization. And there are large reinsurers like Kettle that we've talked about on the show, one of my angel investments. All they do is they buy risk off of other primary insurers books. But primary insurers can also buy risk off of each other's books.

• 1:34:00Ben Gilbert?

  This is like, just to keep bringing it back to Vegas for fun. If a sports book messes up and sets the line in the wrong place, and then they end up like 70 30 on, you know, are the Patriots going to win? Or the Buccaneers going to win? I can't remember if they were playing the Super Bowl, but just throwing names out. They will go to another casino and bet the other side to basically make it so that they're, sure, they're not going to make as much money on a sort of expected value basis, but now at least they're not overexposed on one side versus the other.

• 1:34:29David Rosenthal?

  Exactly, exactly. And your example, I mean, Tom Brady's going to win either way. So like. That's the bet to make, but.

• 1:34:37Ben Gilbert?

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

• 1:34:41David Rosenthal?

  There's probably a way to make that bet somewhere. I love it. We digress though. We digress. So this plan actually Buffett is like, that's a good plan. That's like a creative plan. That could work. So he gets Kay. Remember Geico's in Washington and Kay knows everybody in Washington. So he Buffett doesn't actually know Jack. He gets Kay to broker an introduction for them. They meet at Kay's house in Washington. Buffett grills Bern for hours and he's like, oh yeah, this guy's gonna do it. So just like the first time that Buffett met Geico, when he goes, takes the train down.

• 1:35:24David Rosenthal?

  He meets Laura Davidson and the very next day he liquidates 75% of his portfolio to load up on Geico.

• 1:35:31Ben Gilbert?

  To impress Ben Graham.

• 1:35:32David Rosenthal?

  The next day after the dinner with Bern at Kay's house, he buys $4 million of Geico stock at $2 a share. So he, he loads up, he's all in.

• 1:35:44Ben Gilbert?

  How much of the company is that?

• 1:35:46David Rosenthal?

  I didn't actually disentangle that versus what he would buy in what's going to happen next. So it's some meaningful percentage, but after what happens next Buffett's going to end up with a third of the company.

• 1:35:59Ben Gilbert?

  Right. So this is like high, single digit, low double digit that he just bought of the company.

• 1:36:03David Rosenthal?

  Yeah, probably in the double digits. So now that goes back by Buffett. Bern is the man for the job. Things are looking up, but they still need capital to operate. Like they're, they're out of money. They're going to sell off some of the risk, but they've got claims that are happening now that they need to pay off. So they need to go raise money. So Buffett tells Bern to go up to New York and do the rounds with the investment banks and line somebody up to do a secondary equity offering out there.

• 1:36:36David Rosenthal?

  None of the big establishment banks want to touch this situation, except for one. There's one bank that is willing to take on enough risk and enough risk to their reputation of what could end up being a broken offering here, which all the, you know, white shoe banks are like, eh, we don't do broken offerings here.

• 1:36:56Ben Gilbert?

  So I don't actually remember who this was. I'm going to guess by the relationship that gets forged for future events that it's Solomon Brothers.

• 1:37:05David Rosenthal?

  It is Solomon Brothers, indeed. The bank of liars poker, Michael Lewis fame, which we will definitely come back to in a sec. They're the only bank that is willing to underwrite what ultimately ends up being a $76 million convertible debt deal, convertible into equity that they underwrite. Buffett flies to New York and tells, and it's not just Solomon Brothers, it's one specific person at Solomon Brothers, a guy named John Goodfriend, who is a rising star there. Remember that name, folks. So Goodfriend and Solomon underwrite the $76 million deal. Buffett flies up to New York to sit down with Goodfriend and tell him, hey, look, I

• 1:37:50David Rosenthal?

  know this is going to be a tough deal to get through, even Solomon Brothers' famous sales distribution channels, even your famous prescriptionists out there. If things go sideways, Berkshire, we're willing to underwrite the deal and do all of it, but we're going to do it at a much lower price than what you go out with if the deal is broken. So Goodfriend's like, all right, great. At least I'll go trade on your name then, at least, and say, tell all my clients, like, hey, Warren Buffett already owns a larger percentage of this company and he's willing to.

• 1:38:23Ben Gilbert?

  Okay. So what do you mean trade on his name? Like, what do you mean Buffett will do it all but at a lower price? Like, he would buy the whole offering? Like, if they're trying to sell a whole swath of stock at a certain price, is this the convertible preferred that they're selling?

• 1:38:36David Rosenthal?

  Yeah, this is the convertible, I think it's convertible debt, not convertible preferred.

• 1:38:40Ben Gilbert?

  Okay.

• 1:38:41David Rosenthal?

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

• 1:38:56Ben Gilbert?

  It's like when an insider in a venture round tells the company, hey, like I'm good for my pro rata in whatever round you raise, go raise the round, go get a price. If you were to lead an inside round, you know, I'd lead it like if you wanted to do an inside round, but it won't be at the price where you could go raise your external.

• 1:39:16David Rosenthal?

  Your external round. Exactly. That's exactly what's going on here. So girlfriend's like, all right, I can work with that. You go out, Solomon Brothers, sales and trading, famous, aggressive sales and trading desk. They get the deal done. It ends up being oversubscribed. And Buffett does end up, even though it's oversubscribed and goes out at the price that they wanted. Warren's like, all right, I think this company is going to make it. He ends up buying 25% of the deal, even at full price for Berkshire. The stock, even though they just issued new convertible into equity, you know, securities, the stock jumps to eight bucks a share because people realize, hey, this is, this is good news.

• 1:39:54Ben Gilbert?

  This thing could make it out alive. And if it does, damn good business.

• 1:39:58David Rosenthal?

  Yeah, exactly. So GEICO has now got two of the three problems solved. It's got, it's capitalized. It's got enough money to make it through. It's laid off a lot of the tail of, of risk in their current book over the coming years with the reinsurance deals that they do. But it's still not pricing right. So the thing about auto insurance and most consumer insurance is you need licenses to operate in any state. And part of the licensing process is you have like a license to sell insurance at a certain price. You can't just like arbitrarily change your price on your customers. That's,

• 1:40:38David Rosenthal?

  the regulators don't allow that. It's a super weird market. It's not like, you know, we could change the price of the LP show tomorrow if we want.

• 1:40:46Ben Gilbert?

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

• 1:40:52David Rosenthal?

  Exactly. So this is Bern's time to shine. This is amazing. This is my favorite moment, I think, of this whole second episode. So he goes out to all the states individually and he explains the situation and be like, hey, we were mispricing. We got to raise prices on consumers. And some of the states are okay with it. Apparently, New York, right off the bat, is like, yeah, we get it. Okay, fine. But some of the states are playing hardball, and in particular, New Jersey is playing hardball. Huh. I mean, New Jersey, right? Like, Bern himself. The Florida, the north. Yeah, Bern himself is from New Jersey. So he's like, all right, you want to, you want to do some mafia tactics here? I'll do some mafia tactics. So I'm just going to read what happens next from the snowball, because I can't do this any better than, than

• 1:41:37David Rosenthal?

  Alice did it here. So Bern marched into the New Jersey Commissioner's office with a copy of the company's license stop rate in the state in his pocket and told Sheeran, the Commissioner, that GEICO must have a rate increase. This is now a quote from Ben. He had a sour ass little wizened actuary at his side who'd been fired by some insurance company and had a bone to pick. Sheeran said, my numbers didn't justify a rate increase. I did all the arm waving and stuff that I could, and Mr. Sheeran was intractable. So Bern pulled the license out of his pocket, threw it on Sheeran's desk, saying, I have no choice but to turn in the license, or something to that effect with more four-letter words. He then drove

• 1:42:22David Rosenthal?

  off to the office with his tires screeching, sent out telegrams to 30,000 policyholders in New Jersey, canceling their insurance that day, and fired 2,000 New Jersey employees in a single afternoon before Sheeran could go to court and get an injunction to stop him. Bern says, it showed everybody, all audiences, I was serious about this, and then I was going to fight for the life of this company, no matter what, including walking out of a state, which wasn't done back then. Bern's impalement of New Jersey had exactly that effect. Everybody knew he was serious.

• 1:43:03Ben Gilbert?

  And so did they end up actually just vacating New Jersey and just didn't serve policies there?

• 1:43:07David Rosenthal?

  They literally vacate New Jersey. They vacate a bunch of other states and Bern is like, if I didn't, he's like, look, this is war. We're either gonna, we gotta reprice. So either we're gonna burn the house down, you know, and vacate these states, or we're gonna be allowed to reprice. So GEICO, by the end of this, has shrunken down to only seven states.

• 1:43:33Ben Gilbert?

  The original Travis Kalanick.

• 1:43:35David Rosenthal?

  I know, I know. It's amazing. He has shrunken down to only seven states. Bern has completely swapped out everybody in the company. Famously, a lot of the sort of middle and lower management in the, in the company was from the, you know, the old days, undisciplined days. Apparently at one point, the then existing HR director is giving a speech in front of the company and Bern gets so upset that he storms on stage and fires him on the spot, literally like gives him the hook, takes him on stage, points at somebody in the audience and says, you're the new HR director. Brings him up on stage. Amazing.

• 1:44:15Ben Gilbert?

  Is Lorimer still there at this point in history?

• 1:44:17David Rosenthal?

  Lorimer is long retired at this point in time, but he's like cheering on from the sidelines and he's advising Bern and Buffett behind the scenes.

• 1:44:25Ben Gilbert?

  Wow.

• 1:44:26David Rosenthal?

  Amazing. So they shrink GEICO down to only the seven states and DC that let them change the rates. And they right the ship and they price the policies appropriately. The company gets profitable. It stops losing money. It starts growing again and then would go on to become, what did Bern say in the annual meeting this weekend? I think that they have like what?

• 1:44:49Ben Gilbert?

  Second largest insurance company.

• 1:44:51David Rosenthal?

  Yeah, Progressive is slightly larger, but I think they each have about 25% of the US market. Something like that. Incredible.

• 1:45:00Ben Gilbert?

  And he spent $47 million from 1976 to 1980 to buy, is it about half the company?

• 1:45:08David Rosenthal?

  So, yes, by the time the debt offering closes, and then when the share price jumps, I assume the debt converts at that point, Berkshire owns 33% of GEICO. But because he's Warren and because this is now like one of his jewels, he runs the playbook that he's also helping K. Graham run at the Post, GEICO starts buying back its own stock. So by the mid 90s, we're fast forwarding to, we'll get to this later in the next episode. By the mid 90s, Berkshire has 50% of the company without putting in another dollar.

• 1:45:46David Rosenthal?

  And then in 1995, Berkshire buys the rest of GEICO that it doesn't own for $2.3 billion. So they get half the company for 40, 47 million and half the company for 2.3 billion. Either way, they get a hell of a deal because estimates are that GEICO is worth probably about $50 billion today, maybe more.

• 1:46:08Ben Gilbert?

  Wow.

• 1:46:09David Rosenthal?

  So that's 25 billion of value, assuming that's 50 on 45 billion and 25 billion of value on 2.3 billion.

• 1:46:18Ben Gilbert?

  Either way, pretty good.

• 1:46:20David Rosenthal?

  Either way, pretty good. Warren's like, look at me now, feds.

• 1:46:24Ben Gilbert?

  Listeners, even though this is going to be in the final part of the trilogy, we do have to tell you that the, in 1996, the 2.3 billion that was used to purchase the second half of GEICO, you might be saying to yourself, why did it take so long? If he really liked this business forever? Well, Berkshire had a lot of cash tied up and other stuff for a while. And a thing that happened pretty much immediately before this $2.3 billion transaction for half of GEICO was that

• 1:46:54Ben Gilbert?

  Warren had a big investment in Capital Cities and Disney came in and bought ABC Capital Cities, which then of course, in that outright sale, all the proceeds went to good old Berkshire. And that was a little bit more capital than 2.3 billion, but about the same amount that suddenly they had to play with to go put to work somewhere else. And GEICO was where they decided to go put it to work.

• 1:47:19David Rosenthal?

  What better jewel to put that capital into than GEICO? Amazing. So, you know, it's funny, we said on, or I said on the first episode, something that I was totally convinced was right at the time, and now maybe not, where I said that, God, if Warren had just held on to GEICO and not sold, imagine what his returns could have been. You know, who knows what would have happened otherwise, but you know, GEICO almost died, right? Like if he had held on, would he have had this ride anyway and ended up here? He got to buy back in at two bucks a share.

• 1:47:53Ben Gilbert?

  Totally. Yeah, that's a good point. He did get it at an extremely low basis, even though he skipped a few decades of compounding and growing in there. It is also worth pointing out that despite the fact that it is a Buffett mantra to hold businesses forever, hold, hold great businesses that you believe in forever, he can dump a stock just as fast as the next guy. I mean, the way that he dumped all the airline stocks at probably the low point of the COVID stock crash, it was really interesting hearing him on stage last week where he's, he was totally unapologetic for that, thought it was totally the right move. And you could imagine that he easily could have been convinced that that was the right thing to do in the GEICO situation, too.

• 1:48:31David Rosenthal?

  Totally. And all that matters is the long run. Although as Charlie Munger would say, who is it? I think it's Charlie quoting John Maynard Keynes, that in the long run, we're all dead. So.

• 1:48:46David Rosenthal?

  But in the long run, GEICO becomes, you know, one of the major jewels, if not the most important piece of Berkshire, especially given all the float that they generate. I guess that is, that is the big thing that Berkshire and Warren miss over that 20-year period where he's not invested in GEICO is using the float.

• 1:49:06Ben Gilbert?

  Yep. There is a playbook theme I want to pull forward here, which is, and it's actually two themes, and it's important to know how they're different. The first one is identifying things that have far less risk than the market perceives them to have. And that's things like American Express, that's things like him realizing that brands are more powerful than value investors give them credit for, or the magical thing of a monopoly franchise newspaper. But then there's the second category of identifying things that should you act, will have far less risk than the market perceives them to have. And even more importantly, if

• 1:49:45Ben Gilbert?

  you uniquely have the capability to act, then you actually can be value creative. Like the thing that he did with GEICO in making sure that that financing got done, there's not a lot of people out there whose name can be traded on to get an offering done like that. And Buffett's willingness to both strategize and then put his name on the line, and of course, his name wasn't really on the line because otherwise he just would have gotten the screaming deal, but did a thing that he was uniquely suited to do and able to do, meant that in a self-fulfilling prophecy way, the investment was way less risky merely because he was involved.

• 1:50:22David Rosenthal?

  Yep. Oh, boy. Is that ever, is that ever the case? And does Warren ever know it?

• 1:50:29Ben Gilbert?

  David, I figured I'd set you for that next story we got coming.

• 1:50:32David Rosenthal?

  You really, you tossed that ball in the air and I just, I cannot wait to slam it. But before we get to Warren getting punch drunk on his own reputation and ability to

• 1:50:46David Rosenthal?

  To save businesses. So all the, the Geico situation wraps up kind of around 1980 and you know, it's off to the races. The rest of the beginning of the eighties is just more goodness for Warren and Charlie and Berkshire. So finally, when Paul Volcker becomes chairman of the Fed, first at the end of the Carter administration, and then under the Reagan administration, he enacts the, you know, correct fiscal and monetary policy to reverse the terrible inflation that had been happening. And the eighties just become, you know, we're both children of the eighties, like an immense period of prosperity, the eighties and nineties

• 1:51:27David Rosenthal?

  for America. So the eighties are the go-go years, you know, this is Wall Street movie, this is excess, this is everything. And it's a good time for Berkshire in Omaha, too. So we won't go into all the details, but they buy the Nebraska furniture mart from Mrs. B. Incredible story. She then gets upset with the way her children, who are like in their eighties at this point, or nineties, seventies, are running the business. She leaves, starts a competitor across the street at age of 95. When Berkshire has to buy it back for five million bucks and sign a non-compete with her at age 95. Amazing.

• 1:52:08Ben Gilbert?

  There's the Buffalo Evening News in here, sort of the early eighties, which is when Buffett really, is that the early eighties?

• 1:52:14David Rosenthal?

  Yep, early eighties, yep.

• 1:52:15Ben Gilbert?

  He gets into a good old fashioned newspaper war. He's trying to be the franchise newspaper in the city, ends up sinking tons of capital in, gets into not a fight, but a few disagreements and has some words with, with Charlie about the right things to do. But, you know, Buffett's a committed guy. There's a bunch of stuff that happens in here that we could do 10 episodes and wouldn't have time for it all.

• 1:52:36David Rosenthal?

  Totally. He, he goes to war with the efficient market hypothesis theorists, which is amazing. And just like at Columbia's 50th anniversary event of the security, the publishing of security analysis, he gives this talk where he just like, he calls it the super investors of Graham and Doddville. It gives this long talk. Eviscerating the efficient market hypothesis, folks, economists, which basically their hypothesis is that all markets are efficient and that changes in price are simply volatility and around the efficient price and that volatility equals risk. And so that is market beta and that's, that's all there is. Like when, if you're investing, there is no such thing as investing acumen,

• 1:53:18David Rosenthal?

  you're just taking volatility risk in the market. Charlie has a one word retort to that, which is bullshit. Warren goes through and eloquently explains why that's wrong.

• 1:53:30Ben Gilbert?

  Well, and, and they just have a lifetime of investment results to prove it. Like they actually can generate alpha. How like otherwise you have to believe that Buffett has, uh, has flipped a coin and it's come up heads, you know, a hundred thousand times in a row. Like you're into these crazy probabilistic scenarios where, you know, at some point it's too many standard deviations away from the mean for you to believe that it's possible.

• 1:53:52David Rosenthal?

  Yep. And the reason this is important for what's about to come is, so like all this is theory, right? This is like economic theory, but it has a very, very important real world consequence in the eighties, which is that people who, you know, use to their advantage, the academic thinking behind the efficient market hypothesis, that risk equals volatility, they realize that, well, wait, if risk equals volatility and you can't get alpha, the way you can get more returns, if you take something that has a certain degree of volatility, and then you lever the crap out of it with debt, you magnify that volatility and then you can

• 1:54:36David Rosenthal?

  magnify your returns if you arbitrage that. And so this is when, you know, the eighties are the debt fueled decade, you know, mortgage backed securities get introduced, all the junk bonds and Michael Milken and DLJ and corporate raiders and corporate takeovers are all happening.

• 1:54:55Ben Gilbert?

  Massive leverage buyouts. You get barbarians at the gate.

• 1:54:58David Rosenthal?

  Yep. Arjana Bisco, everything. Yeah. And Buffett and Charlie are sitting and looking at this and they're like, volatility being risk is nonsensical. Risk is risk that you go out of business and introducing debt into the equation.

• 1:55:14David Rosenthal?

  Far from not changing your risk, it massively increases your risk because what causes you to get game over? It's when you go bankrupt and you can't pay off your debt. So while they're out there espousing this philosophy, in the meantime, well, they do do the Capital Cities deal finally with Tom and Dan.

• 1:55:36Ben Gilbert?

  So Buffett stepped off the board of the Post to be able to do the Cap Cities investment?

• 1:55:40David Rosenthal?

  The Cap Cities deal. So he invests 517 million in Cap Cities to help them buy ABC. 517 million, like, I mean, that's a big chunk of money, but he can do this at Berkshire now. Like, they're enormous. They're a multi-billion dollar company. He's a billionaire himself already at this point.

• 1:55:56Ben Gilbert?

  And so if these guys are anti-leverage and they're trying not to, you know, do the LBO thing where you lever up and then buy something and then have to make debt payments forever out of the profits of the thing that you just bought, how does the Cap Cities transaction work then where Cap Cities is able to be the minnow that swallows the whale?

• 1:56:14David Rosenthal?

  Well, a big part of it is that 517 million in equity from Berkshire coming in to the deal.

• 1:56:21Ben Gilbert?

  I see. So they, they basically have a very large post-money valuation effectively because they're issuing a whole bunch of new primary shares out of Cap Cities to be able to have enough money on the balance sheet to buy ABC.

• 1:56:34David Rosenthal?

  So I don't know, I don't have notes on exactly what the structure of the deal was. I believe it was some Cap Cities stock plus the 500 million in equity from, I think it was convertible equity from Berkshire. And then they probably did add on some debt as part of it, but you know, like a reasonable amount of debt, like, especially with a predictable cash flow business, you know, that, that's reasonable. Where Warren and Charlie get themselves into not just like trouble on the order of the trouble with the feds earlier in the episodes, or actually the multiple troubles with the feds earlier in the episodes, but real honest to God, like.

• 1:57:16David Rosenthal?

  Frankly, the worst moments of their lives trouble is when they think that their reputation and their ability to save companies and their ability to be this capital partner to companies is so great that they can come in and save Wall Street itself.

• 1:57:33Ben Gilbert?

  Or Wall Street from itself.

• 1:57:35David Rosenthal?

  Or Wall Street from itself with Solomon Brothers. Oh, boy. Here we go. So remember, we told you to remember John Goodfriend and Solomon Brothers, who had helped GEICO do the convert deal that Warren backstopped. You know, Warren thinks Goodfriend walks on water at this point. They're the only bank that was willing to do this. Warren famously and Charlie, they famously hate Wall Street. They hate banks, but like, you know, okay, you did be a solid.

• 1:58:09Ben Gilbert?

  And we know these guys, so we feel for them a little bit. They don't, they don't seem like the enemy. They're kind of our, you know, we know them.

• 1:58:17David Rosenthal?

  Yep. So we're now in the late eighties. Goodfriend has become the CEO of Solomon Brothers. They've gone through a series of mergers and acquisitions. The firm is much bigger than it was before. It's now publicly traded and Solomon already was the debt king. But in this environment of the debt fueled, everything we were just saying about the eighties, Solomon is like the king. They sold the first mortgage backed security, an inglorious honor, if there ever was one. They go deep into junk bonds, derivatives, all kinds of hairy stuff.

• 1:58:59David Rosenthal?

  It gets so extreme at Solomon that in 1980, I think it was 86, a young Princeton graduate shows and aspiring writer shows up at the firm as a new hire. Michael Lewis on the bond, sales and trading desk and ends up writing a book about his experiences, intended to be as a cautionary tale of the wretched excesses of Wall Street.

• 1:59:28David Rosenthal?

  Has the exact opposite effect called liar's poker.

• 1:59:31Ben Gilbert?

  It's inspirational beacon for a generation of Wall Streeters to come.

• 1:59:35David Rosenthal?

  Look, I remember reading the book when I was graduating from Princeton and about to go work on Wall Street myself. And it's just, it's like the social network 20 years later. It's like, you know, this was meant to be at most, at best, a, you know, show all sides of a complicated situation, and at worst, a cautionary tale. And instead, like, a whole generation of young people just look at it and they say like, I want me some of that.

• 2:00:02Ben Gilbert?

  Sounds fun. You get rich? Great.

• 2:00:06David Rosenthal?

  I'll just read one quote from the book where Lewis writes about the famous 41st floor home of the bond traders at Solomon. He says, "Because the 41st floor was the chosen home of the firm's most ambitious people, and because there were no rules governing the pursuit of profit and glory, the men who worked there, including the more bloodthirsty, had a hunted look about them. The place was governed by the simple understanding that the unbridled pursuit of perceived self-interest was healthy, eat or be eaten. The men of 41 worked with one eye cast over their shoulders to see whether someone was trying to do them in, for there was no telling what manner of man had leveled himself to the rung below you

• 2:00:50David Rosenthal?

  and was now hungry for your job. The limit of acceptable contact within Solomon Brothers was wide indeed. Here was capitalism at its most raw and its most self-destructive."

• 2:01:04Ben Gilbert?

  I love Michael Lewis. I could make every single one of his books a carve out at some point.

• 2:01:08David Rosenthal?

  So great. So despite this immense success in the bond market, Solomon and Goodfriend have gotten themselves in kind of a pickle here because it's working too well. All these traders, all these wolves of Wall Street, they are generating so much money, but they're demanding that they're going to get paid all the money. So there's, all of it gets paid out in bonuses to all the traders who are constantly demanding more and threatening to leave for other firms, that the corporation itself, the, you know, recently public, now public company, Solomon Brothers, the profits are actually declining.

• 2:01:48Ben Gilbert?

  I was seeing some stat that even in a year, I think it was in a year where they underperformed the S and P 500, there were still over a hundred people at the firm that were paid out over a million dollars in their bonus.

• 2:01:59David Rosenthal?

  Oh, totally. Yeah. One year where that happened famously, one guy, just individual trader made a $23 million bonus in one year in like 1987 or something.

• 2:02:12Ben Gilbert?

  Right. Which is, I don't know, two, two X, two and a half X by inflation today.

• 2:02:16David Rosenthal?

  Whatever it is, that's a damn lot of money.

• 2:02:19Ben Gilbert?

  For a rent seeker, you know, like where's the value creation there?

• 2:02:23David Rosenthal?

  Oh, there is only value destruction happening here. There is nothing being created.

• 2:02:28Ben Gilbert?

  Or certainly value capture.

• 2:02:29David Rosenthal?

  Absolutely. So because Solomon itself is suffering, they start attracting the attention of corporate raiders and in particular, Ron Perlman.

• 2:02:40Ben Gilbert?

  Revlon, right?

• 2:02:41David Rosenthal?

  Yeah, Revlon. Yeah. He buys out Solomon's existing largest shareholder and he starts agitating like he's gonna, he's gonna take over Solomon Brothers, which good friend of nobody at the firm, because they just want to keep paying themselves the bonuses. They of course don't want this. So you've got basically the 100% most anti Buffett and Munger, at least what they say, situation possible here. A bunch of people at the firm, management, quote unquote, there's no management going on, but like employees just simply enriching themselves at the cost of shareholders while ratcheting up risk in the economy and creating

• 2:03:22David Rosenthal?

  no value. What could be better? Good friend calls Buffett. He's worried about, he doesn't want to get thrown out by Perlman. And he says he needs to cash in the favor from the Geico deal. And Warren, you know, Berkshire has such a reputation of being the white knight and saving companies at this point that.

• 2:03:40Ben Gilbert?

  And being management friendly.

• 2:03:41David Rosenthal?

  And being management friendly. Exactly. It's all going to come back to bite them. That good friend says like, Hey, if I can get Warren to join the board, I'm going to get Perlman off, off my rear end. So Warren and Charlie agree to do it. And.

• 2:03:56Ben Gilbert?

  And they both take board seats, right? They get two seats.

• 2:03:59David Rosenthal?

  They both take board seats. So here's how it goes down. It's Rosh Hashanah weekend in September 1987. And Perlman is like a Orthodox Jew. So he's, he's out of commission, you know, he's not, he's not doing anything over the weekend.

• 2:04:12Ben Gilbert?

  And of course.

• 2:04:13David Rosenthal?

  Good friend knows this. And so he times everything. So he gets the deal done in secret with Buffett and Berkshire over that weekend. Berkshire buys $700 million of convertible preferred stock in Solomon. So more than the money than they put into Cap Cities with a 15, 15% interest rate coupon on attached to that convertible preferred stock.

• 2:04:41Ben Gilbert?

  So it's like the company's in dire straits and the CEO really doesn't want, or really does want to incentivize these particular shareholders to become shareholders.

• 2:04:50David Rosenthal?

  Well, that's what's so disgusting about this situation is like the revenue line essentially of the firm has never been better. Like these traders, you can say what you will about what they're doing, but they are raking in money for the top line. But then they're paying it all off to themselves in bonuses. So the firm is suffering. Capital's coming in. They do this really tough terms deal simply to save, you know, again, quote unquote, management's own skin. It's, it's really something that goes on here. And I mean, it's crazy that Warren and Charlie and Berkshire do this. Even, you know, loyalty is super important to them and good friend and Solomon having saved Gecko.

• 2:05:36David Rosenthal?

  Anyway, they do it. Both of them join the board and there's this famous scene where they fly to New York, the two of them over this weekend. Maybe this must be like on the Friday and they, they go to the Solomon building to sign the papers. And good friend takes them on a tour and they go to the balcony overlooking floor 41. It's like a callback to child Warren overlooking the balcony of the stock exchange and being like, wow, there's so much money here. I want me some of that. And they're looking down on what's essentially like a seething Gladiator pit below. And Charlie looks at Warren and he says, so you really want to invest in this, huh?

• 2:06:18David Rosenthal?

  And Warren supposedly just is kind of like silent for a minute. You can just see him being like, what am I getting myself into? And he finally says, mm hmm.

• 2:06:30David Rosenthal?

  In like a slow, and then he goes and signs the papers.

• 2:06:33Ben Gilbert?

  And, you know, credit to Charlie for asking the question, but Charlie follows him into the pit too. And

• 2:06:38David Rosenthal?

  Oh, 100%.

• 2:06:39Ben Gilbert?

  And joins the board as well.

• 2:06:41David Rosenthal?

  Totally. And probably regretted it every day after. So they do the deal. This is September of 1987. October 19th of 1987 is Black Monday, when the Dow falls 22.6%.

• 2:06:58Ben Gilbert?

  Oh, my God.

• 2:06:59David Rosenthal?

  In essentially a flash crash. I had this confused in my mind. I thought Black Monday in 87 was the long-term capital management thing. No, that happened much later. This was actually a flash crash. So like, nobody really knows why this happened. Of course, the market was overheated. Of course, there was way too much leverage in the system. But things recover pretty quickly. That's not what triggers a meltdown. So Solomon, of course, gets crushed. Like, the rest of Wall Street, they lose $75 million in in trading losses on that day. The stock gets crushed. But they're not in any better or worse shape than any other investment bank. But the stock is way down. So Buffett and Munger show up to their first board meeting

• 2:07:42David Rosenthal?

  after this happens, which is like the next month, maybe in November. And good friend in management puts a deal on the table to reprice all employees' stock options because the stock is down. And Buffett and Munger flip. They're like, wait a minute. You guys lost a ton of money for the firm. Like, we as, you know, as shareholders in the firm, like, our stock that we just invested, our 700 million is now worth less. And you guys are saying you want to take advantage of this lower stock price to reprice all of your options, that you're then just going to trade out of immediately as soon as they vest and liquidate cash?

• 2:08:20Ben Gilbert?

  Right. It's, it's like, you know, no one here wants to become bigger owners of this thing. You all just want a quick arbitrage opportunity.

• 2:08:26David Rosenthal?

  Exactly. Exactly. But they acquiesce, you know, they don't really want to fight with management. And they also know that if they get into kind of a public fight with, if this becomes public, that they're fighting with good friend and the board.

• 2:08:40Ben Gilbert?

  Stock price drops even further.

• 2:08:41David Rosenthal?

  Price is going to drop even further. They've got $700 million at stake here. And so they don't really want to do that. So, I mean, we're already pretty far down the slippery slope here. This is when the real slide starts. So not only do the options get repriced, but then in secret, behind the board's back, good friend reaches a deal with the head of the best performing trading desk on the floor, the so-called magical arb desk, the bond arbitrage desk, run by John Meriwether, who runs the domestic fixed income arbitrage group, to directly pay them 15% of all the trading profit they

• 2:09:24David Rosenthal?

  make as bonuses. So like, no longer even just like, hey, management will decide your bonus at the end of the year. It'll be based on the performance of the firm. It's now like, you're a prop shop. Like 15% of all of your profits, you're going to take home with none of your own capital at risk and on the hook for none of the downside when you have losses.

• 2:09:46Ben Gilbert?

  Wow. That'll incentivize some bad behavior.

• 2:09:50David Rosenthal?

  Yeah. So things limp along for the next couple of years. Warren and Charlie aren't thrilled about everything that's going on. But so then, the shoe drops. In August of 1991, Buffett is on vacation in Reno, Nevada, and he gets a call from, not from good friend, from Solomon's president, Tom Strauss, and its general counsel, Don Ferstein, who, behind the scenes at Solomon, Don is referred to as, quote, "the prince of darkness" for all of the dirty work.

• 2:10:27Ben Gilbert?

  Things I never want to be called.

• 2:10:29David Rosenthal?

  That he, all of the sticky situations that he gets Solomon out of and all the dirty work he does, this is amazing. You can't make this stuff up. So Warren's on vacation, he gets a call, this is not a call you want to get. And so Warren's suspicious, they get on the phone and they're like, well, our firm's outside counsel, Solomon's outside counsel, has figured out that the head of our government bond trading desk, Paul Moser, who reports to Meriwether, he's apparently been violating some of the Treasury Department's rules when bidding on government bond auctions, the way the Fed controls the money supply, the way that interest rates are set, they bid out bonds, government debt, and then all the big investment banks get to place bids in terms of interest rate, and then the government

• 2:11:14David Rosenthal?

  selects which banks buy the debt.

• 2:11:17Ben Gilbert?

  And there's only a few, what is it, 40 banks or something that are even allowed to be involved in these auctions, that are allowed to have the privilege of buying debt from the US government?

• 2:11:27David Rosenthal?

  Yeah, this is the way the money supply gets into the economy. To be one of these banks means that you are controlling, you have a direct relationship with the federal government and the Treasury controlling the economy. So Moser's been violating the rules, they don't say exactly how or why, and that they've suspended him and Solomon is gonna, you know, notify their regulators about this. And Warren's like, oh, the prince of darkness is calling me for this? Like, that doesn't seem that bad. Like, you violate some rules, okay, but like, while this is really important and prestigious, this is like, kind of a sleepy part of the firm. You wouldn't think that the government bond desk is something that

• 2:12:08David Rosenthal?

  could like, blow up the firm, you know, you'd be more worried about the arb desk, per se. So he's like, all right, well, you know, call Charlie, he's the lawyer between us, you know, he'll, he'll know what to do.

• 2:12:19Ben Gilbert?

  Just, just some rules, like, how bad could it really be? I'm sure it's just some regulatory tapes.

• 2:12:24David Rosenthal?

  Some regulatory stuff. So they're like, oh, yes, we've, we've already talked to Charlie. He's totally cool with it, like. No worries. So Warren's like, okay, great. I'm gonna go back to vacation. Well, turns out Charlie wasn't totally cool with it. And turns out that maybe Moser did a little bit more than just violate the Treasury's bidding rules. What he actually did was he submitted fake bids on behalf of clients for the Treasury auctions. Both fake bids for real clients and fake bids for fake clients. So on behalf of people who weren't even customers of Solomon Brothers. And his goal in doing this was to essentially corner the market in this auction.

• 2:13:09David Rosenthal?

  Win all of the auction for these Treasury bonds. And put the squeeze on all the other participants who needed the bonds to sell to their, resell to their clients. So that he could then sell at a massive profit in the market, which he did.

• 2:13:26Ben Gilbert?

  And of course, while it's illegal to bid on behalf of your clients who are not placing orders. And then it's even more illegal to bid on behalf of imaginary clients. It's also illegal to try and corner the market on a given auction. There are rules in place that say things like, you can't try and bid for more than 35% of any given auction. Because we need it to be able to be spread around. Because we don't want this big second market for people, you know, paying a big premium. Cause someone managed to go get 90% of the allocation.

• 2:13:59David Rosenthal?

  Totally. And the reason they don't want this to have happened is what actually happens as a result of Moser's actions. Like three or four small financial firms that couldn't absorb this price volatility go bankrupt. So this is like, this is real, what the dude did. And I think he did this like four or five times. And the net of all of it was Solomon made an incremental $4 million in profit. All this for $4 million. So it turns out he did it multiple times. It turns out that Meriwether, who was his boss in the chain of command and good friend, knew about this four months ago. And they knew about it because the SEC started investigating

• 2:14:43David Rosenthal?

  and got in touch with them. And when that happened, the general counsel, the prince of darkness, told good friend that what was happening here was criminal, but that technically, they didn't have any technical obligation to report it to anyone.

• 2:15:00Ben Gilbert?

  The CEO is sending letters to the general counsel without notifying the board. Like, hey, I got this letter from the SEC. They're investigating us, but just our GC needs to know about it.

• 2:15:11David Rosenthal?

  Yep. Not notifying the board, not notifying the shareholders of the public. And equally, if not worse, not notifying the other regulators that this is going on. So the SEC is investigating, but they haven't found any. They just found some irregularities. Internally, Solomon found, oh, no, this is criminal. Like, what's going on here? So they don't tell anybody. And not only that, they don't fire Moser. They leave him in place, running the government bond desk. And there's no audits or controls on what he's doing. So basically, they're like, don't do that again. Wink, wink, wink.

• 2:15:49Ben Gilbert?

  Wow.

• 2:15:50David Rosenthal?

  And then they turn around and look the other way. So at this point in time, the SEC has like, figured out like, yeah, these aren't just irregularities. They figured out what's going on. Word starts to get out on Monday after this, August 12th. The Wall Street Journal runs a big piece about how bad this could be and how little is known. Solomon's counterparties, their lenders and their trading partners, start like getting cold feet about dealing with Solomon and all the markets that they operate in. And Solomon, it turns out, they're the second biggest bank on Wall Street at this point in time. They have 150, 150 billion of capital, like in the markets.

• 2:16:33Ben Gilbert?

  Wow.

• 2:16:34David Rosenthal?

  But they only have $4 billion of equity. All the rest of it is like, short-term paper and debt and leverage and like everything that has been building up in the 80s. So they're like, what's that? 60 times levered on their capital?

• 2:16:51David Rosenthal?

  And all of a sudden their counterparties start getting cold feet about trading their paper and 50 billion, five zero billion of the 150 billion rolls over every single day. That's really short term paper. So if there's a problem, it's going to be instantaneous and the firm is dead. So also on that same day, on that Monday, this is probably the worst thing that happens. So the Federal Reserve sends a letter to good friend and Solomon saying, I think only good friend and, and the general counsel see this, saying that it is quote, deeply troubled by both the firm's actions and lack of actions. And it is questioning whether it can continue to have a business relationship with Solomon Brothers.

• 2:17:36David Rosenthal?

  This is the Federal Reserve, unless the firm Oh my God. responds to this letter and significantly changes its business practices within the next 10 days. Now, if the Fed ends its business relationship with Solomon, game over, like it's dead. All the counterparties are going to stop trading with Solomon. Wow. Like it's, it's literally game over instantaneously. Good friend and the G C just sit on the letter. They don't tell the board, they don't tell anyone else, they don't tell the Cheryl. Nobody knows about the letter except the two of them. The feds assume that the board knows about the letter. That's like Solomon is doing something, but good friend and, and the G C covered up.

• 2:18:18David Rosenthal?

  Buffett, by this point in time, he gets in touch with Charlie and Charlie's like, uh, yeah, you should be concerned about this. So the board convenes, they issue a press release saying that, you know, they're looking into this and figuring out what happened. The firm's stock drops 30% that day. The Fed meanwhile is like, you guys aren't responding to our letter. Like they're just getting angrier and angrier every day that goes by. On Friday of that week, the New York Times runs a headline, Wall Street Sees A Serious Threat To Solomon Brothers. And the Fed finally has had enough. The lead investigator running the case at the Federal Reserve calls good friend and

• 2:18:59David Rosenthal?

  says, you need to resign like today and you need to install new management or else, you know, essentially. When good friend gets that call, he calls Buffett, who's still in Omaha. And he essentially just tosses him the keys to the firm and he's like, I'm going to resign.

• 2:19:17David Rosenthal?

  Somebody has to step in and run the place and deal with this. And it's probably got to be you. So good luck with that.

• 2:19:24Ben Gilbert?

  Wow.

• 2:19:25David Rosenthal?

  Not quite in that language, but, uh, but that's essentially how it goes down. Pretty intense stuff. Warren and Charlie are legitimately frightened at this point.

• 2:19:35Ben Gilbert?

  And the argument there is like, hey, I have to be out. Uh, we don't have any ideas for who's next.

• 2:19:41David Rosenthal?

  Yep. There's no plan. There's no management.

• 2:19:43Ben Gilbert?

  Whoever steps in has to have the reputation to be able to save this firm. And like, nobody wants their investment to go to zero. So I pick you as the person who seems like you might have, be able to save this thing.

• 2:19:55David Rosenthal?

  Well, at this point, the fiduciarily responsible people are the board. And who are the most prominent people on the board? Warren and Charlie and Warren specifically. So like, you know, good friend's already out as CEO. So there's nobody left except Warren to come in.

• 2:20:15Ben Gilbert?

  Wild.

• 2:20:16David Rosenthal?

  Deal with this. So Warren immediately gets on a plane to New York. And he goes and meets with the Federal Reserve and tries to like, understand and sweet talk them. This is amazing to me. The Fed, I think, assumes that Warren knows about their letter. But he doesn't. And that wires still get crossed in this meeting. So Warren doesn't understand what the worst case scenario really is. And cryptically, at the end of the meeting, Buffett's trying to, you know, sweet talk them and buy more time. The Fed tells Warren that to, quote, "prepare for all eventualities." I.e. that they're going to yank the right to, you know, participate in the Treasury auctions and Solomon's going to go down the tubes.

• 2:20:58David Rosenthal?

  So now it's Friday night into Saturday morning and Warren has to make a choice. He can walk away from Solomon, say, I'm resigning.

• 2:21:08Ben Gilbert?

  And, and $700 million goes up in flames.

• 2:21:11David Rosenthal?

  But he can walk away. Or the other option is he can take the reins of the company and try and steer this thing through. As he's thinking about it and talking with Charlie, he realized he actually doesn't have a choice because if he walks away, his reputation is toast. If he walks away 100% his reputation is toast. And like, he loses 700 million, like, that'll be fine. But like, what company is going to do a deal with Berkshire Hathaway ever again after this?

• 2:21:39Ben Gilbert?

  Right.

• 2:21:40David Rosenthal?

  And if he stays, you know, probably there's a good chance he's not going to be able to navigate through this, in which case his reputation is also toast.

• 2:21:48Ben Gilbert?

  Which this brings up that George Bernard Shaw quote, that I think it's Charlie who likes to quote it, "Never wrestle with a pig. You just get dirty, but the pig enjoys it."

• 2:21:58David Rosenthal?

  Exactly.

• 2:21:58Ben Gilbert?

  You can imagine that moment where they're standing out, looking over the trading floor, knowing that they're about to wrestle with a pig, and then this is the eventuality of what happened with that.

• 2:22:09David Rosenthal?

  Yep. And this is where, as he's realizing this, so Alice writes in the Snowball quote, "At some point during that long, horrible Friday, he recognized with a sickening jolt that investing in Solomon, a business with problems over which he had essentially no control, had put it all at risk." And by all, she means everything. Not just the 700 million in Solomon, like, everything that Warren and Charlie together have built. You know, they're both on the board. So he decides he has to take the job. He decides he's going to become interim chairman of the company, and he installs the head of the investment banking division, a guy named

• 2:22:50David Rosenthal?

  Derek Mon, as the CEO. That's just kind of like a, I mean, the investment bank, that was the one thing that Solomon was not good at, was the investment banking advisory at business. So he gets installed simply because he's just far away from all the toxicity. And then on Sunday,

• 2:23:10David Rosenthal?

  The board, Warren and Charlie and the whole board is at the office in New York. They're trying to figure out what to do. When a letter arrives from both the Federal Reserve and the Treasury Department, they haven't heard any response to their deadline of things have got to happen. Wow, yeah. And thus far, nothing has been announced from Solomon. So they say they've had enough. It's the end, like no more negotiating. They're pulling the plug that afternoon. And by the time the market opens in Tokyo, which is like, I think, late afternoon New York time. Uh, this is Sunday afternoon, so Monday morning Tokyo time. It's going to be announced that the Fed has revoked Solomon's licenses and it's over.

• 2:23:51David Rosenthal?

  So Warren directs the board and the lawyers to start preparing a bankruptcy filing. And in the meantime, he desperately starts trying to call anybody he knows in the government, using all of his Washington connections to like, try and stay the execution here. And he finally reaches the Treasury Secretary Nick Brady, which is the Treasury and the Fed jointly made this decision. And Warren literally like breaks down on the phone crying and like begs him, says, this is the most important day of my entire life, begs him to stay the execution and just give them like a little more time and figure things out. And so Brady is like moved by this.

• 2:24:35David Rosenthal?

  If I literally Warren Buffett, you know, if there's anybody in the world who could get the government to change its mind. And he says like, okay, let me go talk to, let me go talk to Greenspan, the head of the Fed, and figure out what we're going to do. So hours go by. It's all in limbo and they're just sitting in, in the Solomon office, drafting up a bankruptcy filing. And then a call comes in from the Assistant Treasury Secretary.

• 2:25:08David Rosenthal?

  Do you know who that was at the time? Call comes in for Buffett.

• 2:25:12Ben Gilbert?

  No.

• 2:25:13David Rosenthal?

  One Jerome Powell.

• 2:25:16Ben Gilbert?

  Oh, my God.

• 2:25:17David Rosenthal?

  Then Assistant Secretary of the Treasury. Incredible. And he says, look, well, like, this is bad. We're not going to allow Solomon to bid itself in Treasury auctions anymore. So we are gonna, like, we need our pound of flesh. We will, however, because of you, Warren, because you're stepping in and you're committing to making changes, we will allow Solomon to continue to place bids on behalf of its clients. And he says, will that work? And Warren is like, that'll do.

• 2:25:54Ben Gilbert?

  Whoa.

• 2:25:55David Rosenthal?

  Yeah. So he literally gets the government to reverse their decision. Unbelievable.

• 2:26:02Ben Gilbert?

  That's insane.

• 2:26:03David Rosenthal?

  So now they have to deal with the aftermath.

• 2:26:05Ben Gilbert?

  Also, it's incredible that Good Friend never showed the letter because I assume he was a shareholder too. And of course, it's going to come out that there was a letter sent at some point. So it's not like he's saving himself any, like, legal liability by not disclosing it.

• 2:26:19David Rosenthal?

  Well, I think what happened, I don't know how far in advance he had gamed this out. What ends up happening, I'll tell the story in a minute of how this all wraps up. But as this is going down, like concurrently that weekend, Good Friend and his lawyer, they end up, because Warren still, he doesn't know the extent of Good Friend's, you know, deception here and cover up. And he doesn't know about the letter. He doesn't find out about the letter until later. And so they go out to dinner and Good Friend and his lawyer, personal lawyer, try and get Warren and Charlie to sign a severance package for him, leaving the company, they want a $35 million payout.

• 2:27:02David Rosenthal?

  Your reaction is priceless there. That's wild. Isn't that wild? So they're trying to get the money as always. And fortunately, you know, they're dealing with Charlie Munger here. So Charlie basically stonewalls them. He was, this is amazing. I don't have the quote written down here, but this would later get arbitrated and Charlie would testify in the arbitration under oath that Charlie's natural way of, you know, being with other people is he turns his brain off when he's not interested in things and he wasn't interested in what they had to say. And so he was just muttering and not saying anything. It's amazing. In the negotiation? Yeah, the negotiation. So they don't agree to anything. They don't sign anything.

• 2:27:47David Rosenthal?

  And ends up after years of fighting this in arbitration, gets $0 as he should. Anyway, so they get the save, the stay of execution from the government. And then they have to deal with the aftermath. So Warren has no interest or ability in actually running day to day Solomon Brothers. But what he can do is he can deal with the government and the public. So he instructs Mann, the new CEO, to clean up the firm inside. You handle everything inside the building and his instructions are get it right, get it fast, get it out. In terms of dealing with all the corruption in Solomon.

• 2:28:28David Rosenthal?

  And basically the first thing that happens that week is he gets, Warren gets summoned before Congress to go testify in front of Congress. And this is brilliant. So they bring in MTO Munger, Tolson and Olson, of course, to represent him in all this. And Roy Olson comes in and Roy suggests this brilliant step that goes a long way, I think, towards saving Warren and Solomon. He suggests that they proactively go to the government and say, we will waive our attorney client privilege. So everything, which is, this is like extraordinary. This never happens. So they're going to the government and they're saying,

• 2:29:11David Rosenthal?

  All of our communications and anything that MTO finds at Solomon, we will share with you.

• 2:29:18Ben Gilbert?

  Wow. And it makes sense to do that because they're the new guard. So it doesn't, there's no way it can reflect poorly on Warren, Charlie, MTO. It's only going to be negative for all the people that Warren wants to fire anyway.

• 2:29:33David Rosenthal?

  Exactly. So Alice writes in the snowball about how perfect this was. The more evidence that MTO found on employees that were guilty, the more proof it would show the government that Solomon was cooperating. And that Buffett was cleaning everything up and the employees meanwhile, must cooperate or be fired. Since none of anything that they would say would be protected by attorney client privilege with MTO. So the employees' options were get fired or answer MTO's questions. And anything you say to MTO is going directly to the government.

• 2:30:06Ben Gilbert?

  Yeah. So Warren's not there to protect anyone. He's there to, uh, this is a win-win for him.

• 2:30:11David Rosenthal?

  Exactly. Exactly. This has Charlie's fingerprints all over it.

• 2:30:14Ben Gilbert?

  Huh.

• 2:30:15David Rosenthal?

  So Warren goes in front of Congress, probably one of the most famous statements that Buffett's ever made. And, uh, you know, certainly corporate history where he's being grilled by senators about what he's going to do at Solomon and how he's going to turn it around. And he says, uh, the way that Solomon's going to operate going forward is lose money for the firm and I will be understanding. Lose a shred of reputation for the firm and I will be ruthless.

• 2:30:42Ben Gilbert?

  Hmm. Fascinating.

• 2:30:44David Rosenthal?

  And he kind of puts on a show and he wows Congress. And Solomon ends up getting out of this thing with, they settle in the next few months with the government for a $190 million fine. Plus a $100 million restitution fund, which I assume is maybe to go to the other financial institutions that were hurt by the cornering of the market in the treasury auctions.

• 2:31:10Ben Gilbert?

  Restitution's gotta be it.

• 2:31:12David Rosenthal?

  Yeah. Certainly that's a lot of money, but like, this is amazing. He pulls this out. The firm survives. And so obviously Solomon is, you know, damaged, but over the next few years. They recover and they end up a few years later.

• 2:31:29Ben Gilbert?

  When does Warren, when's he able to like actually step out of day to day?

• 2:31:33David Rosenthal?

  As soon as possible. Basically, as soon as the settlement hits, he's like, and I'm out as chairman. He stays on the board, though. He keeps the investment in and, but he's no longer day to day. So this happens in 92. Six years later, in 98, Solomon gets acquired by Citigroup, the former travelers insurance, as you put a pin in for $9 billion, which means that Berkshire gets a return of $1.7 billion on their $700 million investment, plus the 15% coupon that they had been cash coupon that they'd been getting.

• 2:32:12David Rosenthal?

  So unbelievably, I mean, it literally takes Warren and Berkshire to the brink, but this ends up being a really good investment for them.

• 2:32:24Ben Gilbert?

  Wow. It makes so much sense why Buffett then had the, the quote, "It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently." I bet he sort of imagines looking out on the trading floor when reflecting on how he might do things differently.

• 2:32:41David Rosenthal?

  Totally.

• 2:32:42Ben Gilbert?

  I do wonder if he looks back on this and thinks, was it worth it for that investment return? Probably not.

• 2:32:48David Rosenthal?

  100% not. 100% not. You know, the irony is like, 100% not. But this only kind of adds to the myth of Warren and Berkshire.

• 2:33:00Ben Gilbert?

  Right. Now he's the guy, he can, he can save even the cesspool of Solomon brothers. You know, what can't he do?

• 2:33:06David Rosenthal?

  What can't he do? So this is where we're going to leave part two, but there's one coda before we do. Ben, you may know, you probably know, but listeners, I will ask, do you know what other organization after this whole debacle that John Meriwether, the head of fixed income trading at Solomon Brothers, would go on to found two years later in 1994?

• 2:33:38Ben Gilbert?

  David, is it something that had a crisis where you mentioned it earlier in this episode?

• 2:33:44David Rosenthal?

  Yes, it would be. My God, this is just crazy.

• 2:33:48Ben Gilbert?

  Is he part of the group that was the former Solomon Brothers, people that went to do long-term capital management?

• 2:33:55David Rosenthal?

  Not only was he part of that group, he was the leader of that group. Literally John Meriwether, founder and CEO of Long Term Capital Management.

• 2:34:05Ben Gilbert?

  Wow. And he was the guy between good friend, who was the CEO and the guy directly underneath him was the guy doing the auction violations. Wow.

• 2:34:16David Rosenthal?

  Yup. How crazy is that?

• 2:34:20Ben Gilbert?

  Did any of these guys ever go to jail?

• 2:34:22David Rosenthal?

  The only guy who went to jail was Paul Moser, the guy who did the auction violations and he went to jail for four months. Isn't that unreal?

• 2:34:33Ben Gilbert?

  Wow.

• 2:34:34David Rosenthal?

  Like literally, I mean, the thing that we didn't talk about in this history, you know, certainly the government was influenced by Warren's reputation and his pleading. But they were also scared too. Like, nobody knew what would happen if you just took the second largest investment bank in the world out back and shot it. Like, it for sure would have created a financial meltdown. And then, of course, you know, 16 years later, we got to, that was, this was the dress rehearsal for what we got to see actually happen in 2008.

• 2:35:07Ben Gilbert?

  Wow. Which of course Berkshire also, uh,

• 2:35:11David Rosenthal?

  was an active participant in.

• 2:35:13Ben Gilbert?

  Yeah. Mostly, mostly in buying the dip.

• 2:35:16David Rosenthal?

  Yeah.

• 2:35:18Ben Gilbert?

  But, uh, wow, we'll, we'll save that story. It's funny. We've got for part three, we'll have the whole tech bubble. We'll have 2008. We'll have the tech bull run of the last however many years and kind of the future of where do we think Berkshire goes from here? But this feels like a good place to leave this part.

• 2:35:36David Rosenthal?

  Yeah. I mean, we intended this to be one episode on Berkshire originally. And it's like the, the deeper we go into it, as we were doing the research, I mean, this, this Solomon episode, I knew that this had happened. I didn't know that this had happened.

• 2:35:52Ben Gilbert?

  No, I mean, the only thing that I really knew was that Warren Buffett was called on to act as the head of Solomon Brothers when they were under duress and his reputation alone was what saved it. But like, that is really true. Like that alone, it's not just like that he was acting as the head of the bank in a riskless way. Like, he risked the whole future of Berkshire to make this happen.

• 2:36:17David Rosenthal?

  Yeah.

• 2:36:17Ben Gilbert?

  In fact, when you, when you think about the return, turning 700 million into one point, what, or he made 1.7 billion over, how many years was that? Like six or seven?

• 2:36:26David Rosenthal?

  I think he made it, it was a billion. So I think it was 700 million in and then 1.7 out, but he got the coupon payments also. So.

• 2:36:35Ben Gilbert?

  So it's maybe like a 200% return over, over six, seven years. So good, but not for this risk.

• 2:36:42David Rosenthal?

  Yeah, definitely not for this risk.

• 2:36:45Ben Gilbert?

  Wild.

• 2:36:47David Rosenthal?

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• 2:36:53Ben Gilbert?

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• 2:37:04David Rosenthal?

  Yep. In the crazy speed of today's AI world, shipping fast is just table stakes now. It's basically trivial to build and deploy your app constantly. The real advantage is how quickly you learn what changes actually created value for customers and how fast you can use that signal to guide what you ship next.

• 2:37:24Ben Gilbert?

  This is where Statsig comes in. It brings experimentation, feature flags, and product analytics into one unified system. So teams can ship safely, test rigorously, and directly link what they changed to how users actually behaved.

• 2:37:37David Rosenthal?

  So if you want to make learning your competitive advantage, whether you're building new AI experiences or just evolving your existing core product, go to statsig.com/acquired to get started.

• 2:37:48Ben Gilbert?

  Well, I think before we talk about power, we should do a quick review of the businesses that they had owned outright during this part of their history. Cause I think people have a general sense of the stuff that they own now, both through the businesses that they own wholly and through their ownership of big public companies like Kraft Heinz or of Coca-Cola. But let's review the things they bought in the seventies and eighties and owned outright. Sees Candy, Wesco Financial, The Buffalo News, Precision Steel Warehouse, Nebraska Furniture Mart, takes this B, Scott Fetzer, Feckheimer Brothers, Borsheim's Jewelry,

• 2:38:26Ben Gilbert?

  HH Brown, Central States Indemnity. And then in 95, the finishing touch on Geico, they bought Hellsberg Diamonds and RC Wiley Home Furnishings. So there's like a lot of Berkshire that you think about today that they don't own yet.

• 2:38:43David Rosenthal?

  Yeah. On the public equity side, the main positions we talked about, The Post, Cap Cities, Solomon Brothers, and one that we didn't talk about that we'll talk about more next time in Coca-Cola. I think those represented significant parts of the value. But again, as we've seen, they're taking a hands-off approach here.

• 2:39:03Ben Gilbert?

  As we analyze the power, we think about them as sort of two different business lines. Cause it does feel like the, the business activities day to day are very different between those two things, which actually you see reflected in the management structure of the business flashing all the way forward to 2020. You have Ted and Todd on the sort of investment management side, buying publicly traded companies or investing in publicly traded companies. And you've got Greg and Ajit on the wholly owned subsidiary side.

• 2:39:31David Rosenthal?

  The insurance and Ajit running the insurance businesses and Greg running all the non-insurance businesses.

• 2:39:37Ben Gilbert?

  Non-insurance, which is funny because it's like so diverse that you don't have a way to label it. So it's just insurance and non-insurance.

• 2:39:42David Rosenthal?

  Yep.

• 2:39:42Ben Gilbert?

  So, okay, let's talk first about the wholly owned businesses. So. The business activities there are prospecting, identifying the whole landscape of businesses you could buy, evaluating those businesses on their fundamentals, making the decision to invest or not invest, and then making sure that you leave or install the correct management in place to make those businesses hum over a long period of time. And then, of course, capital allocation, where you're making sure that you're deciding if that business is one that you like consuming capital and you want to funnel more capital to that business so it can reinvest in growth. Or if that's a capital producer and you maybe like

• 2:40:25Ben Gilbert?

  your jacket linings business or your stamps business, you don't want that business consuming any more capital and that should just spit off capital that gets sent to the head office for reallocation. So with that preamble, those are sort of the business activities of the wholly owned subsidiary side of the business.

• 2:40:42David Rosenthal?

  Yep.

• 2:40:43Ben Gilbert?

  Now, of the Hamilton Helmer Powers, which basically enable you to, in a long-term way, get a durable, sustainable differential profits above your nearest competitors. So here, I think we should think other conglomerates. We should think private equity firms.

• 2:41:00David Rosenthal?

  Definitely private equity firms.

• 2:41:01Ben Gilbert?

  Yeah, think about these companies going public. SPACs weren't really a thing yet, so that wasn't an option on the table. Strategic acquirers, I think, were, though. The question is which of the seven powers sort of applies to Berkshire?

• 2:41:14David Rosenthal?

  Yeah, this is gonna be fun. Because it's not network economies. It's not our usual favorite.

• 2:41:22Ben Gilbert?

  It is definitely not. I'll make a first run at it and say counterpositioning. And certainly, counterpositioning versus anybody that's running money.

• 2:41:31David Rosenthal?

  Yep.

• 2:41:32Ben Gilbert?

  And I think to more finely articulate that, I opened this episode by talking about the fact that... Warren chose a very unique structure in choosing not to have a fund or a partnership, but instead to have this operating business Berkshire that he uses the capital from to invest off the balance sheet. And it's very interesting when you have that structure and you're not generating fees and you're not thinking about raising another fund and you're not getting a carry or a promote, you have just as much downside risk as upside benefit. And so your incentives are pure in a way.

• 2:42:13Ben Gilbert?

  You only want to make financial decisions that, you know, buy low, sell high or buy low, hold forever. And there's no other way that you make money.

• 2:42:23David Rosenthal?

  Well, your only focus is long-term value creation because nothing that you're going to do isn't going to increase your fees or increase your value in any set, you know, fund life period of time or anything like that.

• 2:42:40Ben Gilbert?

  Right. So that makes you counter positioned to private equity firms.

• 2:42:43David Rosenthal?

  Yeah.

• 2:42:43Ben Gilbert?

  And so then the question becomes, is that actually power in a positive way? Or is it somehow negative? Is it just a disadvantage? Are they counter positioned to you? Because let me put it this way.

• 2:42:57David Rosenthal?

  Cause they can pay more.

• 2:42:57Ben Gilbert?

  There's certainly deals that a PE firm would do that Warren wouldn't do because the price is too high. But is the opposite true? Can Warren get deals done because the PE firms have an opposite business model?

• 2:43:09David Rosenthal?

  Well, it's interesting, right? Because this is so obviously not a tech company in so many ways. And this market that Berkshire operates in, the market of acquiring and investing in other companies is not a winner take all market. So what's interesting is like to succeed, they need a niche and they certainly carve out their niche exceedingly well with counter positioning versus other players. The best, you know, we didn't talk about this on the episode, I'm going to say, because we didn't have time, but like, what is time on an acquired episode anymore?

• 2:43:49David Rosenthal?

  But this is how they win the Mrs. B deal, the furniture mart deal. You know, Buffett sits down with Mrs. B and says to her, because she has other offers to buy the furniture mart for more money and says, you know, you, you could certainly take those offers and I'm not going to pay what the private equity firms and others will pay. But at the end of the day, those firms are, what's motivating them is selling your business for more money. And they may say lots of things to you and be aligned and love you and want to keep you and your family in place running it. But at the end of the day, they're going

• 2:44:32David Rosenthal?

  to do anything to maximize them selling the business for more money within a set period of time so that they can make their fees. I'm not going to do that. I'm genuinely going to leave you and your family to run this.

• 2:44:44Ben Gilbert?

  Right. It's like having a longer lens is actually the counter positioning here.

• 2:44:49David Rosenthal?

  Yeah.

• 2:44:50Ben Gilbert?

  And simultaneously holding true the belief that, or holding it to be true, that keeping the family in place to manage it is the long-term value maximizing decision.

• 2:45:00David Rosenthal?

  Yeah. Both of which are true.

• 2:45:02Ben Gilbert?

  Both of which can be true.

• 2:45:03David Rosenthal?

  Can be.

• 2:45:03Ben Gilbert?

  Depending on if you acquire the right business.

• 2:45:06David Rosenthal?

  It gets back to the fight with the efficient market hypothesis theorists and the nature of debt, which all of the private equity firms are using to buy these companies, to layer up the companies and buy them. If the goal is to have the companies operate sustainably the longest and generate the most cash flow over truly the longest period of time, you don't want to use debt because debt is going to increase the chance that the company is bankrupt. And so if as a seller, if you care about the legacy of the company, either for, you know, whatever your family working in the business, you know, they're making money, you retain a part of it, or, or just for the legacy of the business, your interests

• 2:45:46David Rosenthal?

  are aligned with Warren's then because he wants the cash flows over the longest period, which means he's going to avoid debt.

• 2:45:54Ben Gilbert?

  Such a good point.

• 2:45:55David Rosenthal?

  Hmm. Okay. So yeah, I agree. Counter positioning for sure.

• 2:45:59Ben Gilbert?

  Definitely branding.

• 2:46:01David Rosenthal?

  Definitely.

• 2:46:01Ben Gilbert?

  I mean, like, that's probably actually the place where you start. Like, the Warren Buffett brand just enables you to do things that, like, literally the Solomon thing, like, anyone else crying on the phone to the federal government probably wouldn't have impacted them. But because it was Warren's brand crying on the phone.

• 2:46:20David Rosenthal?

  Totally.

• 2:46:21Ben Gilbert?

  It's trite, but I'm trying to use the the Seven Powers language here.

• 2:46:25David Rosenthal?

  A hundred percent. I think the Seven Powers actually apply a lot. Yeah. Counter positioning applied, but yeah, branding, 100%. Like Warren Buffett and Berkshire Hathaway's money is worth more than the equal amount of money from somebody else.

• 2:46:39Ben Gilbert?

  Yep, absolutely.

• 2:46:41David Rosenthal?

  Okay, so I don't think there's necessarily scale economies. I mean, maybe you could argue a little bit that, like, the scale of the insurance businesses and the float enables more investing, which enables more operating businesses, which, you know, maybe, I think that's a little bit of a stretch.

• 2:46:56Ben Gilbert?

  During this phase, so it's interesting, today, I think they actually have diseconomies of scale because they just have too much capital that they need to put to work, but we'll save that for the next episode. I do think this period was the one for the first time where they did realize some economies of scale, where there is this, like, nice middle ground, where, like, if you're really small, then you can't invest enough money to have sharp elbows on a board. But if you have too much money, then all you can buy is Apple. And, you know, nothing else moves the needle for you enough. But during this period in the 80s, they had, like, the perfect amount of money, where they could be activist investors on boards and throw their weight around, and that would deliver enough return for them to be needle-moving.

• 2:47:36David Rosenthal?

  Yep. Yeah, actually, that's a really good point. That's a good point. It's a power right now, but it's not a, like, sustainable power.

• 2:47:44Ben Gilbert?

  Yeah. Oh, that's interesting to think about.

• 2:47:46David Rosenthal?

  Okay, I don't think they're switching costs.

• 2:47:48Ben Gilbert?

  No, and that's all I've got for this so far. The question is, which of those apply to the public investing side of the house?

• 2:47:56David Rosenthal?

  Oh, well, the one I was going to talk about, I always have such a hard time thinking about this power. And as Hamilton says, it is the trickiest of the seven powers. But is there process power here at Berkshire?

• 2:48:09Ben Gilbert?

  I mean, it's funny, it's like, thinking about process power in a super small organization feels like a de facto no, because they always uses the example, the Toyota production system, that like, the system was so complex, it couldn't be written down to be re taught to someone else, because it's held in so many heads. And the decisions are all made by one person. So like, is there process power in Warren's head?

• 2:48:29David Rosenthal?

  Well, he calls Charlie, but Warren ultimately makes the decision.

• 2:48:33Ben Gilbert?

  I think there's a liberal interpretation of process here to make that the case.

• 2:48:38David Rosenthal?

  It's funny, because I was thinking for public market investing, I was thinking like, that might be the only really arguable one.

• 2:48:46Ben Gilbert?

  You freaking efficient market hypothesis to you.

• 2:48:53David Rosenthal?

  Well, no, I'm definitely not an efficient market hypothesis disciple. But I do, I think there are definitely market inefficiencies, as this episode shows. But I don't know that Berkshire had any sort of unique, any defensible ability versus others to see and then act on them. They acted on the ones that they saw. Other people could act on the ones that they see.

• 2:49:17Ben Gilbert?

  Right. But getting back to that point that I made earlier around identifying things in the market that not only have less risk, but actually exclusively have less risk than the market perceives them to have when you act. I think I was sort of foreshadowing power there, where there are things where Berkshire uniquely could have acted.

• 2:49:43Ben Gilbert?

  And therefore save the company, gotten the deal that they did, were able to join the board, whatever the thing is. And so I'm trying to figure out how to quantify that. So Wapo, Solomon Brothers, these were things that Buffett could uniquely do in an advantaged way versus their competitors, their competitors being all other capital and why?

• 2:50:05David Rosenthal?

  Well, Wapo was kind of Buffett had to fight his way in. It was sort of like, maybe that was like part of developing this power. Cause you know, Kay was sort of like scared of him at first and certainly reluctant. And then Buffett fights his way in. I don't know that like, that was a power. But then, once he was on the Washington Post board and like the mystique of Warren Buffett had started to grow, then I think maybe it becomes something defensible.

• 2:50:37Ben Gilbert?

  Yeah, that's a great point. Well, normally here I would move us onto playbook. I literally think we had discussed every playbook theme during the narrative, during history and facts that I possibly could have brought up here. So I have nothing to add in the playbook section this episode.

• 2:50:55David Rosenthal?

  Yes.

• 2:50:56Ben Gilbert?

  As, as Charlie would say, no.

• 2:50:59David Rosenthal?

  Nothing to add. Value creation versus value capture?

• 2:51:02Ben Gilbert?

  Let's do it. So Buffett definitely created more value in this chapter than in the previous one. Like the previous one, you're buying and selling, you're buying at low prices, you're selling at high prices. Here you're doing things like they legitimately created value for Solomon's shareholders.

• 2:51:22David Rosenthal?

  Yes, they created $9 billion worth of value.

• 2:51:27Ben Gilbert?

  The question is, what other situations in the seventies and eighties did they create value? Certainly for Berkshire shareholders by marrying the insurance businesses and the operating businesses. For Berkshire shareholders to be able to sort of realize the incredible benefits of those two things operating in tandem.

• 2:51:46David Rosenthal?

  I think they also created value for GEICO in the saving GEICO. Now, you know, Jack Byrne did all the legwork himself, but no question having Warren, you know, there, both with the regulators and the government of like, hey, Berkshire Hathaway is behind us now. We're going to be okay. But then also specifically with the financing and with Solomon Brothers and with Wall Street, you know, backstopping the deal.

• 2:52:15Ben Gilbert?

  Yep. Is there value destruction for the American consumer by making it so all those people who had GEICO in the states that they decided to pull out of, lost their car insurance?

• 2:52:26David Rosenthal?

  Hmm. That's a good question. I don't think so.

• 2:52:32Ben Gilbert?

  I mean, how hard is it to go get different insurance?

• 2:52:35David Rosenthal?

  Right. And if GEICO wasn't going to make it if they didn't make those changes.

• 2:52:41Ben Gilbert?

  Right. It's not like they corporate raidered it and went in and it was going to go perfectly fine, but then they destroyed it, Toys R Us style.

• 2:52:47David Rosenthal?

  Now, what was interesting in that story though, was, you know, I think GEICO and Byrne were the first to actually pull out of states. Like, nobody had ever done that before. So they did sort of cross a Rubicon. So yeah, I don't know. It's a good question. Now, certainly Solomon Brothers, you could debate a lot of value destruction there in aggregate.

• 2:53:11Ben Gilbert?

  Oh, from the entire time they were shareholders, certainly.

• 2:53:13David Rosenthal?

  Yeah. Now, did Buffett and Berkshire?

• 2:53:17Ben Gilbert?

  Meaningfully contribute to that?

• 2:53:19David Rosenthal?

  No, probably not. Other than they did prop up corrupt management.

• 2:53:26Ben Gilbert?

  Yeah. Like value capture, to move on to that and hit it real quick, it's Berkshire, it's Buffett. They always do a damn good job of capturing the value they create. No qualms there.

• 2:53:36David Rosenthal?

  Yeah. Interestingly, especially over this period in the life of the company, probably because of the long term. Focus on not selling investments with regard to tax liabilities. You know, Berkshire and its shareholders pay, if you don't sell, you pay no tax.

• 2:53:53Ben Gilbert?

  Right. Massive tax deferrals.

• 2:53:54David Rosenthal?

  Massive tax deferrals. Yep.

• 2:53:57Ben Gilbert?

  All right. Grading. I want to grade this the same way that we graded the last one, which is we are going to look at their pure performance versus the S and P 500 during that same timeframe. And you, you may recall that in the Buffett partnership years, the annualized return was a 29.5% annual return over those 12 years. Historic, legendary. And I think, what did we determine that was something like a 28X? And you actually, that, that 12 years, you could comp nicely against a venture fund and say, if anyone could 28X the money, then they'd be a top decile fund for sure. And the Buffett partnership had the increased benefit of you could take all your money out or put all your money in, in any given year.

• 2:54:42Ben Gilbert?

  You didn't even have to lock it up for the entire life of the fund, the way that a venture fund does. So, you know, slam dunk, I think we call that an A or an A plus. This set of years, we're going to look at 1970. So the year immediately following liquidation of the partnership to 1992. And we were going to look at just Berkshire Hathaway over that stretch of time. Their rate of return, pretty similar, 27.4%.

• 2:55:07David Rosenthal?

  Dang.

• 2:55:09Ben Gilbert?

  Like, I don't know how you like the Buffett partnership years and don't like these. I think this is like,

• 2:55:14David Rosenthal?

  Yeah.

• 2:55:15Ben Gilbert?

  This is the golden years of Berkshire Hathaway.

• 2:55:17David Rosenthal?

  Totally. Wow. I didn't realize that that's what the number was. I mean, it literally is, it's just like Michael Jordan, you know? He went out at the top of his game. He came back and he won three more championships. And then he went to play for the Washington Wizards.

• 2:55:35Ben Gilbert?

  And actually, maybe we will see that last part here in

• 2:55:38David Rosenthal?

  A little bit of a force shadowing.

• 2:55:39Ben Gilbert?

  Buy tech stocks in the next, next chapter. Yeah. But truly, I think there is this scary thing where you sort of look at this and you're like, maybe Buffett does know how to time the market. Like, no one can. And yet, the guy liquidated his partnership in 69, bought back in big in 71, 72, had this run all the way through, you know, the early 90s, started piling up cash in the 90s. And as we'll talk about, wrote a very famous article in 99, you know, the year before the, the dot com bubble burst, articulating exactly how overheated everything was as he was piling up his cash. So he is acting on his thoughts here. Maybe he can time the market.

• 2:56:22David Rosenthal?

  Maybe. Although, well, we'll save this for part three, but I would say track record on market timing has not been great of late.

• 2:56:30Ben Gilbert?

  No. But just to put some numbers around this 27.4% rate of return. If you had bought Berkshire in 1970 on January 1st, which is the day that Buffett distributed it out to everyone when he closed down the partnership, it was 45 bucks a share. And at the end of 1992, and of course, these are what we now call the A shares. In 1992, that was $11,750 a share.

• 2:57:01David Rosenthal?

  Wow. That's

• 2:57:04Ben Gilbert?

  Bonkers.

• 2:57:04David Rosenthal?

  Bonkers. And today it's over 400,000? Is that right?

• 2:57:09Ben Gilbert?

  Yes, it is a record high as of last Thursday and may, maybe up again, again this week.

• 2:57:15David Rosenthal?

  Wow. My hat is off. All right. What more can you say? All right. What more can you say except like, the comparison is Michael Jordan?

• 2:57:24Ben Gilbert?

  Yeah. Well, listeners, we will know more in part three. And thank you for listening to the Empire Strikes Back episode of the Berkshire trilogy. David, you want to do quick carve outs?

• 2:57:35David Rosenthal?

  Yeah, let's do it. So my carve out is a great podcast episode on the Armchair Expert Podcast, which is so good, so good. Dax and Monica do such a good job, so many good episodes recently, but. Seattle Love, the Macklemore episode was amazing. Have you listened to this?

• 2:57:57Ben Gilbert?

  No, I haven't.

• 2:57:58David Rosenthal?

  Oh, you gotta listen to it. It's so great. Lots of Seattle talk. Dax loves Seattle. He recently was in Seattle, so they spent a lot of time talking about it. But Macklemore was so great. They just get into so much great stuff. Lots of discussion about that. Just go listen to the episode. It's fantastic.

• 2:58:16Ben Gilbert?

  All right. Just added it to my queue. Literally pulled out my phone and added it to my Overcast queue. Mine has its roots in something that you said earlier this episode. You mentioned the mafia. You mentioned the state of New Jersey. I, for the first time, am watching The Sopranos, and it is excellent. And I totally see how it kicked off this like, modern, golden era of TV that we have going on. And I think it was lost on me. I mean, I was, what, nine when it first came out, or 10 when it first came out. But it was lost on me all these years where I've loved shows like Mad Men, and Billions, and Succession, and going back and watching The Wire. Like, The Sopranos really did sort of kick it all

• 2:58:59Ben Gilbert?

  off. And it's violent. It's horrifying in many ways, but God is the writing great.

• 2:59:04David Rosenthal?

  So great.

• 2:59:05Ben Gilbert?

  So can't recommend it enough. I am in season 6A, so I am nearing the finish line. So nobody spoil it for me.

• 2:59:11David Rosenthal?

  Amazing. What year did The Sopranos start?

• 2:59:14Ben Gilbert?

  I want to say it was like 97, 98. It was like right around the time The Matrix came out.

• 2:59:18David Rosenthal?

  Wow. Oh, man, that's a throwback.

• 2:59:21Ben Gilbert?

  Yeah.

• 2:59:23David Rosenthal?

  The Matrix.

• 2:59:24Ben Gilbert?

  Wow.

• 2:59:26Ben Gilbert?

  And they share a couple of actors between The Matrix and that, which is, it's, it's old enough where you see people who you know from things later in their career, and you're like, oh, my God, it's a young so-and-so. And I'm feeling quickly like my parents. Like, when I was a kid, I remember watching things with my parents, and they would say, oh, my gosh, this movie has young so-and-so in it. And that's now me.

• 2:59:49David Rosenthal?

  That's amazing. That's amazing. Well, we're hitting that time of life.

• 2:59:54Ben Gilbert?

  We are. Well, listeners, if you want to talk about all things acquired this episode, things we missed, things we caught, little notions that you have that we may not have seen in the research. This is a three parter, so it is not too late to tell us and we can insert these great tidbits into the final part of the trilogy. Join us in the Slack, acquired.fm/slash Slack. You could talk to lots of other people. There's 7,000 people plus David and I, and it's always a great time in there. So you should join us. If you love acquired and want to be a deeper part of what we do here, become a limited partner, acquired.fm/lp. You'll get access to our library of over 50 interviews and

• 3:00:35Ben Gilbert?

  deep dives on company building topics, monthly Zoom calls, and our upcoming Next Book Club with Brad Stone, which we're super, super excited about.

• 3:00:44David Rosenthal?

  Woo.

• 3:00:45Ben Gilbert?

  So with that, if you aren't subscribed and you want a part three, someone sent you this and you're like, I have to make sure I know when part three comes out, and click subscribe in the podcast player of your choice. They may even have an option so you can enable push notifications. So that way you know for sure when that episode drops. And tell your friends, share it on social media. We always appreciate when people share their love, or frankly, if you have some beef and you want to show that publicly too. We're happy for you to do that wherever, wherever you see fit. So thank you for sharing the show. Thank you for listening, listeners. We'll see you next time.

• 3:01:20David Rosenthal?

  We'll see you next time.