Rational Advisor

Charlie Munger is perhaps one of the wisest people when it comes to investing. He’s also Warren Buffett’s partner in crime.

Here’s key points from a Q&A he did for Stanford Law Review

Q&A: Matters with Charles T. Munger
http://www.law.stanford.edu/publications/stanford_lawyer/issues/80/

Charles T. Munger is a man of many interests, much like his hero Benjamin Franklin. Self-taught in a range of disciplines, he’s a strong advocate for interdisciplinary education saying, “If I can do it, many people can.” A student of physics and mathematics before entering law school, he left his mark on the legal profession early in his career by co-founding Munger, Tolles & Olson in 1962—a firm that is today consistently ranked at the top of its field. Now an icon of the business world, he joined forces with Warren Buffett in the mid-1960s—leaving law to become vice chairman of Berkshire Hathaway and a partner in one of the most successful firms in the world.

Over the years Munger has gained a reputation as something of a no-nonsense voice for sound investment strategies and responsible business practices—as well as simple common sense. But lately it is the mythical Greek character Cassandra who is much on his mind. After living through the Great Depression, serving in WWII, and entering the business world in an era of restraint and sensible regulation, he is irritated by what he calls “the asininities” of today’s government and business leaders that led to the current crisis. He saw the financial train wreck coming and voiced his concerns loudly. But almost no one shared them.

“It is painful to see the tragedy coming, to care about all the people who are going to be clobbered, and not to be able to do one damn thing about it,” said Munger,

As we look at the current situation, how much of the responsibility would you lay at the feet of the accounting profession?

I would argue that a majority of the horrors we face would not have happened if the accounting profession developed and enforced better accounting. They are way too liberal in providing the kind of accounting the financial promoters want. They’ve sold out, and they do not even realize that they’ve sold out.

Would you give an example of a particular accounting practice you find problematic?

Take derivative trading with mark-to-market accounting, which degenerates into mark-to-model. Two firms make a big derivative trade and the accountants on both sides show a large profit from the same trade.

And they can’t both be right. But both of them are following the rules.

Yes, and nobody is even bothered by the folly. It violates the most elemental principles of common sense. And the reasons they do it are: (1) there’s a demand for it from the financial promoters, (2) fixing the system is hard work, and (3) they are afraid that a sensible fix might create new responsibilities that cause new litigation risks for accountants.

Very few people realize how much we’ve screwed up. Even in leading law schools and business schools very few people realize that the mess at Enron never could have happened if accounting customs hadn’t been changed.

As part of the response, the U.S. government and governments worldwide are printing money at a rate that is absolutely unprecedented. Should people be worried about deflation?

Sure. But the dangers from what we have to do are less than the dangers that would come if we responded much as we did in the ’30s.

I think it is dangerous to have big disasters in a modern economy. I regard pre-World War I Germany as an advanced, decent civilization. After all, little Albert Einstein got a very good, subsidized primary education in German Catholic schools. But in its economic misery, Germany became dominated by Adolf Hitler. We’ve seen some god-awful people come to power in various miseries in various countries. Enough misery has huge dangers in a world where we have new pathogens, atomic bombs, and so forth. So we can’t afford to have huge economic collapses. I think we have to do what we’re doing. We’re hooked. And so are the other advanced nations.

What I’m hearing from you, Charlie, is “so far so good”?

It is very reasonable to react with the extreme vigor that’s been shown. In retrospect the vigor wasn’t quite enough. I would argue that it was pluperfectly obvious the government had to save all these banks and major investment banks.

How and why do you think economists have gotten this so wrong?

I would argue that the economists have not been all that good at working concepts of good and evil into their profession. Nor do they understand, at all well, the economic consequences of bad accounting.

In fact, they’ve made a profession of driving value judgments out of the subject.

Yes. They say it’s not economics if you think about the consequences of good and evil, and good and bad business accounting. I think what we’re learning is that when you don’t understand these consequences, you don’t have an adequately skilled profession. You have big gaps in what you need. You have a profession that’s like the man that Nietzsche ridiculed because he had a lame leg and was very proud of it. The economics profession has been proud of its lame leg.

So in order to cure the lame leg, you would lean more toward an approach to economics that takes human nature into account?

If you totally divorce economics from psychology, you’ve gone a long way toward divorcing it from reality.

You’ve often said that one of the keys to your success has simply been to avoid making the garden-variety mistakes that you see other people make.

Warren and I have skills that could easily be taught to other people. One skill is knowing the edge of your own competency. It’s not a competency if you don’t know the edge of it. And Warren and I are better at tuning out the standard stupidities. We’ve left a lot of more talented and diligent people in the dust, just by working hard at eliminating standard error.

If you had to characterize a few mistakes that you see executives making, which ones jump out at you?

An extreme optimism based on an inflated self-appraisal is one. I think that many CEOs get carried away into folly. They haven’t studied the past models of disaster enough and they’re not risk-averse enough. One of the very interesting things about Berkshire Hathaway is how chicken it is, how cautious, how low is its leverage. But Warren and I would not have been comfortable with more risk, entrusted with other people’s net worths. There was no reason for our financial institutions to stretch as much as they did, with the leverage, the shady people and the compromises.

A crisis is…

We may be forced into much desirable change. If there aren’t a lot of new jobs in derivative trading, maybe the engineers will have to do more engineering. If you look at the history of Berkshire Hathaway, you will find that time after time we did something that I describe as turning lemons into lemonade. Part of my Berkshire Hathaway holdings came from a dumb investment.

I didn’t realize you made dumb investments.

I certainly did. I think it’s part of a life lived right that you learn how to make some lemonade out of your lemons.

So turn the clock back, what advice would you give to a graduate looking at the world today?

Well, that’s easy. I would avoid fields where prosperity depended to a considerable extent on misbehavior. And I would want to work for people at a business that I admired, and I would take less money to do that.