1994: Why is Salomon Brothers a good business?

AUDIENCE MEMBER: Mr. Buffett, my name is Bill Ackman. I’m from New York City. And my question relates to the appeal of Salomon Brothers as an investment.

You talked earlier about leverage and the dangers of leverage. Salomon is a business which is levered 30-to-1, which has very narrow margins, and earns a relatively modest return on equity, in light of the amount of leverage that they use. What is the appeal of the business to you?

WARREN BUFFETT: We have here today the chief executive of Salomon, Inc., the parent company, and also the chief executive of Salomon Brothers, the investment banking arm.

And, I would say one of the things we — Charlie and I — feel extraordinarily good about are the two fellows that are running that operation. They did an exceptional job under extraordinarily difficult circumstances, as did John Macfarlane, who’s also here today.

The three of them — I mentioned four people in the annual report — and Salomon wouldn’t be here today without those three. And it wouldn’t be the company in the future that it’s going to be without them. They did an absolutely fabulous job.

It’s the sort of business that, as you point out, uses a lot of leverage. It doesn’t — in one way it doesn’t use as much as it looks like and in another way it uses even more than it looks like.

But — it — the test will be: A, whether they control that business in a way that that leverage does not prove dangerous, and secondly, what kind of returns on equity they earn while using it.

You certainly should expect to earn somewhat higher returns on equity when you are necessarily exposed to a small amount of systemic risk and significant amounts of borrowed money, than you would in a business that’s an extremely plain vanilla business.

But, I don’t know whether you’ve met Bob and Deryck, but, I think you’d feel better about having a leverage in their hands than about any other hand you can imagine.

Charlie?

CHARLIE MUNGER: Why don’t we have those three gentlemen stand up?

WARREN BUFFETT: Yeah, you ought to give them a hand.

CHARLIE MUNGER: They really have done a job for Berkshire in this last year.

WARREN BUFFETT: Yeah, I’ll lead the applause for them. Where are they? There they are. (Applause).

I mentioned this before, but it’s worth mentioning again. Deryck took on the job of being the operating head of Salomon Brothers on what, August 18th, 1991.

He didn’t know what — he couldn’t know what he was getting into, exactly. He — two months later or three months later, we’d never had a conversation about compensation. He did not ask me for Berkshire, or my, guarantee for indemnification because he was walking in not knowing legal problems. We didn’t know what we would finally uncover.

And he worked incredible hours to keep that place together, which was not easy.

Bob Denham, I called — I guess on the 23rd or so, 20th. I called him on a Friday. I got home on a Saturday, the 24th of August.

He was living a nice pleasant peaceful life in California. And had a first class law firm, a good group of clients, wife had a good job there.

And I told him I was in a mess and there wasn’t any second choice and three days later he was back in New York and living in a small apartment in Battery City and handling the general counsel’s job at Salomon.

They found John Macfarlane on that Sunday, on the 18th. I think he was running a triathlon or something.

Not a practice that Charlie and I follow, but, ah — (Laughter)

And he was yanked from that and came down, and I think John was over in New Jersey, but he holed up in the Downtown Athletic Club. And it was his job to keep funding what was then $150 billion balance sheet during a period when people right and left were canceling.

It’s not because we weren’t a good credit, but because they just didn’t want to have anything to do with us for a while.

And the World Bank and the State of Texas pension fund and CalPERS, all these people were shutting off funding at a time — and funding in a business is — gentleman just indicated — is the lifeblood of an enterprise like Salomon.

And so those three deserve an enormous hand by — really by the Salomon shareholders — but by this group in turn because we have an important investment. So I thank them publicly. (Applause)