Will Warren Buffett Repeat His Salomon Brothers Role at Goldman Sachs?

Will Warren Buffett's Repeat His Salomon Brothers Role at Goldman Sachs?
Will Warren Buffett's Repeat His Salomon Brothers Role at Goldman Sachs?

At first glance, it may not seem so likely, but there are reasons to give credibility to the escalating speculation about the possibility that billionaire investor Warren Buffett might end up taking the top job at Goldman Sachs (GS).

As Goldman gets tangled in more lawsuits and possibly more investigations, some are increasingly wagering that the investment bank will face a fate similar to Salomon Brothers in 1991, when top executives resigned and were replaced by Buffett.

In fact, similarities between the two situations are quite uncanny. The parallels start in 1987, when Buffett bought $700 million of preferred shares in Salomon Brothers that yielded an annual dividend of 9%. Similarly in 2008, the Oracle of Omaha purchased $5 billion preferred shares in Goldman with an annual dividend of 10%.

Voicing Support of the Embattled

In 1987, Buffett wrote in his always-anticipated letter to the shareholders of his company Berkshire Hathaway (BRK.A): "What we do have a strong feeling about is the ability and integrity of John Gutfreund, CEO of Salomon Inc. Charlie and I like, admire and trust John." (Charlie is Charlie Munger, the vice-chairman of Berkshire and a long-time friend of Buffett.)

Similarly, this year at his annual shareholder meeting in Omaha, Buffett voiced his support for Goldman CEO Lloyd Blankfein, saying he's happy with Blankfein's leadership. Buffett reiterated that support in several media interviews afterward.

In August 1991, Salomon Brothers' top three executives, including Gutfreund, resigned in disgrace after admitting that they had known for at least six months that their firm had benefited from illegal bids to buy Treasury bonds. At that time, Salomon was one of the leaders on Wall Street, and Gutfreund even boasted that it was "the greatest trading organization the world has ever known." Following the resignations, Buffett was named Salomon's chairman and CEO.

The More Things Change. . .

Fast-forward 19 years, and Goldman Sachs is the company at the top of the game in the bond and equity trading business, making eye-popping profits in the midst of a recession and economic downturn. And one of Wall Street's best-paid CEOs, Blankfein, defends his firm's profits and says in an interview to The Times of London that his firm is extremely valuable to society and is only doing "God's work."

Goldman today faces fraud charges from the Securities and Exchange Commission. The SEC claims in a lawsuit that Goldman bet heavily against investments it created and sold to investors, without disclosing that it had, in essence, created those products to fail.

Last week, an Australian hedge fund, Basis Capital, also filed a $1 billion lawsuit in New York against Goldman, saying the bank had misled it into buying an investment it had structured from mortgage securities. Basis claims that Goldman was betting against dubious mortgage securities at the same time it was reassuring buyers that the investments were sound.

However, unlike Salomon in its 1990s case, Goldman has thus far not admitted to any wrongdoing and is planning to fight its lawsuits.

Interestingly enough, Buffett had railed against the kinds of market activity that was at the core of both Salomon and Goldman. In his 1983 annual letter, Buffett said the "hyperactive" trading of the likes of Salomon led to "casino-type markets."

And in 2002, Buffett said the complex financial instruments known as derivatives were "time bombs" and "financial weapons of mass destruction" that could harm not only their buyers and sellers, but the whole economic system. Such derivatives are now at the heart of the lawsuits against Goldman.

Charting Parallel Courses in the Markets

The stock price behavior of both firms during the first few days of their own scandals is also eerily similar. Money management firm Birinyi Associates provided a comparison for DailyFinance: In the fourth day after Salomon's scandal, for instance, its stock was down 13.65%. In the fourth day, after the revelation of the SEC's lawsuit against Goldman, its shares declined 13.75%.

However, Goldman's aggressive stance might be helping it a little. Its stock in the first 40 trading days was off over 26%. But at Salomon, the market wasn't sure if the firm would continue to exist after its top executives quit, and its stock fell 35% in the same time period.

"Salomon, just like Goldman today, was known as the king of Wall Street with a big reputation, and its stock prices reflected that," says Jeffrey Rubin, director of research at Birinyi Associates. "It took a long time for that firm to repair its reputation." And it took a temporary stint by Warren Buffett as its leader to get that repair job underway.