Becoming Berkshire: The Crash of 1970

Issue 16 | 1970 Part 1 - Party's over

Nov 16, 2024

On December 26th, 1969, Buffett wrote to his partners, outlining the liquidation process and providing closing comments.

At the close of the decade, the partnership owned the following:

“Berkshire Hathaway, which he said was worth about $45 per share. About $16 was tied up in textiles, a business that he said was not satisfactory and had an even smaller chance of being so in the future. But he would not liquidate it. Berkshire also owned the more profitable insurer, National Indemnity, Rockford Bank, and Sun Newspapers.”
“Diversified Retailing, worth $11.50 to $12 per share. DRC consisted of only the scroungy Associated Cotton Shops and proceeds from the sale of Hoschcild-Kohn, which he planned to use "for reinvestment in other operating businesses"—implicitly requiring the departing partners to continue to trust his judgment.”
“Blue Chip Stamps, which Buffett said he would probably cash out because the company was planning a stock sale around the end of the year.”1

When asked why he would not liquidate Berkshire Hathway, Buffett responded that he did not “want to liquidate a business employing 1100 people when the management has worked hard to improve their relative industry position, with reasonable results, and as long as the business does not require substantial additional capital investment. I have no desire to trade severe human dislocations for a few percentage points additional return per annum.”2

1970

1970 marked Nixon’s second year in office.

Image gallery for "Full Metal Jacket (1987)" - Filmaffinity

The first twelve months of Nixon's presidency had been remarkably consequential. Vietnam alone would have made them so. But in the Nixon era, in those days before Ronald Reagon would inaugurate his presidency with the declaration that "government is the problem" and Bill Clinton would proclaim that "the era of big government is over"- there was still the presumption that Americans wanted an activist government addressing the nation's ills. And Nixon had met that goal.
Growth alone required it: the country was doubling in population, from 140 million individuals during WW2 to 281 million at the millennium, with tens of millions migrating to southern California, Arizona, and the states of the old Confederacy. Their business, cars, and homes devoured open space, swilled energy, and clogged the air and water with waste.

The Dow Jones

US in the 1970s | Dow jones index, Dow, Dow jones

The beginning of the 1970s is said to correspond roughly to the late spring of 1929. In each case, "warning signals of a coming economic recession, possibly a full-scale depression, and an uneasy Republican administration were present."3

The Federal Reserve was caught between "trying to dampen speculation and inflation and head off a recession." Sounds like 2024!

The Dow started 1970 at around 800, down about 15% from the start of 1969. By April, it had fallen to 724, and President Nixon "tried to stem the tide by saying that if he had the spare cash, he would be buying stocks right now." April was a particularly busy month as Nixon ordered troops to invade Cambodia, and an oxygen tank exploded on Apollo 13. Ground control in Houston rushed to develop an emergency plan as millions around the world watched as the lives of three astronauts hung in the balance.

In May, four Kent State University students were killed and nine were injured when members of the Ohio National Guard opened fire on a crowd gathered to protest the Vietnam War. On that day, the Dow suffered its most significant one-day drop in seven years and finished at 714. On May 5, the Federal Reserve "reduced the margin requirement on stock purchases from 80% cash down to 65%" to increase trading volume. This did not help as the Dow broke through 700, closing at 694 on May 13.

On May 20th, Bernard J. Lasker, a good friend of Richard Nixon and the chairman of the New York Stock Exchange, met with Nixon to plan a White House dinner for top government officials, Wall Street, and business leaders to instill confidence back into the market. The event brought a reprieve from the calamity that was to come.

The Commerical Paper Crisis

On June 21, 1970, Penn Central filed for bankruptcy, which sent shock waves through the commercial paper market.

“The Penn Central Transportation Company was not only the largest railroad in the country but also the sixth-largest firm in the United States and the owner of the most valuable real estate portfolio. Penn Central controlled more than 20,000 miles of track, one-eighth of the nation’s freight, and a network going from St. Louis and Chicago to Boston and Montreal. While its book value and assets were significant, problems lurked beneath the surface. Penn Central was asset-rich but cash-poor.”4

A snippet from a Time article takes you back to the week that Penn Central filed for bankruptcy.

“The nation’s largest railroad succumbed last week to a lethal combination of politics, tight money, mismanagement, and fumbled Government rescue efforts. A federal court ordered the tottering Penn Central Transportation Co. into a bankruptcy reorganization. The order prevents creditors from collecting a mountainous debt, permitting trains to run as usual. Its impact was felt far beyond the railroad. The Penn Central’s financial collapse, the largest in U.S. corporate history, spread anxiety among businessmen and Government officials about the fortunes of several other large corporations—to say nothing of other railroads.”5

By 1969, corporate debt had tripled from 1960 to $47.9 billion. Interest rates were the highest in 100 years, with banking prime rates at 8.5%. “There is a philosophy that the way to cure inflation is to get everybody to stop reaching out. You want them to curl up in a fetal position; that cures enthusiasm. The Fed had the money valve largely shut off and was criticized for cutting off money too abruptly in 1966 and increasing it too fast in 1967 and early 1968.” 6

Some say companies turned to the commercial paper market because the banks curtailed lending. Commercial paper is seen as an IOU, which companies promise to pay back in over 30-60-90 days. “From 1966 to 1970, the amount of outstanding commercial paper more than quadrupled, from $9 to $40 billion.”7

Penn Central was having trouble rolling over its $200 million in outstanding commercial paper, so it worked with the Nixon administration to ask Congress for a loan; however, the House Banking Committee turned them down as it would “ risk hundreds of millions of dollars of the taxpayer’s money in a questionable scheme.”

The Federal Reserve feared that letting Penn Central default on its commercial paper would negatively affect the market. The 1930s brought special provisions for railroads that declared bankruptcy, letting them remain operational and not liquidating their assets. However, companies like Walt Disney and American Express would lose millions of dollars by letting Penn Central default on its Commercial paper. Allowing several creditors to have their short-term loan default would severely tighten the credit market and possibly create a panic on the $40 billion commercial paper outstanding.

To prevent a panic, the New York Fed spent the weekend calling every major bank - “If anybody comes into your bank and wants a loan, give it to him. Then, if you’re all loaned out, come to us, and we'll see that you have the money.”8 The Fed saved the day as Penn Central went bust, and as expected, the commercial paper market went into shock as companies became reluctant to lend out short-term loans. However, companies that would have sold commercial paper were allowed to borrow from the bank. It is interesting to see how one event could cause a domino effect on Wall Street.

Hayden Stone

Glimpses. 34 Glenwood Avenue. | Portland House Stories

In 1964, after the collapse of Ira Haupt & Co. (due to the salad oil scandal), the Fed decided to create a $25 million Special Trust Fund for customers of brokerage firms that had gone bust. Five stock exchange firms had gone belly up by mid-April, reducing the fund to $7 million.

Hayden Stone & Co. was a major American securities firm founded in 1892 and was the third-largest wire firm in the 1960s. In 1968, gross receipts hit an all-time high of $113 million; however, its record-keeping was so terrible that the Coast Guard had to be called in to assist with back-office filing. You would think this was a sign of things to come. The joke was that Hayden Stone was so disorganized that “you could peel the wallpaper off the wall, deliver it to Hayden Stone, and get paid for it.” It became evident that the company would have to declare bankruptcy on September 11, 1970, as its capital became impaired after a string of bad investments.

“A minimum of $25 million from the trust fund would have been needed to pay the overhead while the firm’s affairs were straightened out. The firm’s overhead had been running at $5 million a month; the cost of litigation would have likely been $40-70 million. Hayden Stone’s 90,000 customers would have been frozen in place. The cash and securities owed by Hayden to other firms would have forced those firms under; perhaps another fifty firms could have gone out of business.” 9

A crisis committee was formed to find new capital for Hayden Stone. The committee found a dancing partner for Hayden but needed the approval of all 108 subordinated lenders for the merger. To make matters worse, the Chicago Board of Trade announced its plan to suspend Hayden for insolvency unless additional capital was raised. Every noteholder signed except for Jack E. Golsen, who previosly pledged $1.2 of his firm’s shares under false pretenses. Jack was OK with Hayden Stone going under as he wanted justice served and was tired of being pushed around by Wall Street. Not even a call from Richard Nixon could convince Golsen. The night before Hayden Stone was set to be delisted, Golsen received a call from his childhood friend, Alan C. Greenberg of Bear Sterns and Company, asking Golsen to work with Lasker. Golsen signed 10 minutes before the deadline, and another crisis was averted.

Partnership Dissolution

As partners began to cash out and the partnership unwound, Buffett found himself with $16 million in cash. That summer, Buffett celebrated his 40th birthday by picking up more shares of Berkshire Hathaway and Blue Chip Stamps, a topic of our discussion for part 2 of 1970.

Jimi Hendrix Live 1970 Photograph by Chris Walter

Lastly, a bit of housekeeping: my daughter’s school is having a Winter See’s Candies Fundraiser, and given this is a newsletter about Berkshire Hathaway, I figured I might as well share the link below: