Tuesday, 13 November 2012

Charlie Munger's Iconoclastic Musings

Expert Author Steven PomeranzSome of you may have heard of Charlie Munger, Warren Buffett's lesser known investment partner at Berkshire Hathaway. Munger is now almost 90 years old and about two-years back gave a talk in California, right on the heels of the financial crisis.

I've summarized the key points of his talk and want to share them with you today. See, Munger is a really interesting man who calls it like he sees it - he's a fierce speaker who peppers his talks with mild cuss words and isn't shy of expressing his opinion and taking on the establishment and its legends.

As he moves into his nineties, Munger has cut back on his speaking engagements and this talk was likely one of his last more extensive discourses.

So here are some of the many things he said that day.

When asked about the financial crisis and why so many smart people got it wrong, Munger said that the question was something he himself continues to wonder about even today. Munger then goes on to cite anecdotal evidence of how a lot of really smart people have consistently made stupid decisions, or at least what he calls stupid decisions - his words, not mine!

And, he says, at Berkshire, they focus less on brilliance but more on how to not make stupid mistakes. He believes that academia has failed us where professors at our best universities routinely turn out asinine ideas (again, his word on the talk, not mine!), indoctrinate students with them and send them out unprepared for the real world.

For example, he cites the Efficient Market Theory - a popular theory that states markets are mostly efficient and that all available information was priced into a stock, and that stock prices essentially represented fair value as determined by the collective intelligence of the market.He calls the Efficient Market Theory pure bunk because in Munger's significant own experience over multiple decades of highly successful investing, he's witnessed multiple instances where the market priced securities well below and well above what they're intrinsically worth... and Munger says he just can't seem to understand why even the brightest minds on Wall Street get fogged up with ideas and beliefs that are simply dead-wrong, and continue to hang on to these fallacies over long periods of time.

He also cites the Capital Asset Pricing Model as pure bunk - it's a model that's popularly called CAPM and was on top-tier MBAs' lips as they headed into Wall Street for coveted jobs with investment banks and hedge funds. In fact, there was a while when almost everything on Wall Street was somehow valued using CAPM... but Munger, for his part, thinks that CAPM too is pure bunk andlaments that it was taught to economics and MBA students for almost a decade or more before folks in their ivory towers realized that little of that model actually works in reality.

Munger is particularly ferocious when it comes to attacking the social sciences, of which he counts Economics a part. He thinks the social sciences have collectively done more damage to Wall Street than good. He praises science and engineering for their usefulness to society based on solid logic, delivering practical solutions that benefited the world without confusing it. But he gives none of that benefit to the social sciences where, Munger believes, hogwash theories hold sway more than logic and common sense.

In general, he also laments that in this world we live in, most people are economically tied to one job or another and this financial dependence often keeps them from breaking away from idiotic norms and almost subconsciously makes them buy into the ideas that their workplace espouses... sort of like drinking the office kool-aid. And he wishes more people would break the mold and use simple logic and original thinking, free of nonsensical models.

Oh, and by the way, a lot of his talk lamented on the woes we've gotten ourselves into as a nation and the institutions that got us here.

Getting back to Wall Street's love of financial models, he laments that there are way too many bright minds that are sucked into Wall Street and on a recklessly massive scale, apply fundamentally flawed models... with flawed assumptions... with significant leverage... with near-zero human input... to wreak havoc in the markets... with billions of securities traded daily for little fractions of profit, controlled solely by computers.

He's also not happy about the introduction of derivatives - made worse by a lowering of margin requirements. Munger sees this as legalized gambling on a grand scale within the stock market context, and says he was never surprised when he saw bubbles burst time and time again... he says he was always sure of when these bubble situations developed but, as it is with such trends, could never predict when they'd finally feel the effect of gravity and coming crashing down.

He's also concerned about overly-free free markets because as he puts it they allow powerful forces of unreason to flourish. And he blames this blind belief in an unregulated free market for many decisions made by former Fed chairman Alan Greenspan where he'd stand aside and essentially let the markets do their thing with near zero regulation... with devastating results... repeatedly.

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