Charlie Munger's 3 Categories of Investment: In, Out & Too Tough

55. Charlie Munger’s Wisdom Nuggets: DJCO Annual Meeting 2014: Part 3 Nugget 13-18


Nugget 13: Drinking To Excess Is Not Good. It’s Worse If Your Bonds Drink Too.

Q: What about succession planning at the Daily Journal?

Munger: When I came out to California, there was this playboy and he spent all his time drinking heavily and chasing movie stars. In 1950 he had ten million dollars that he got by being part of a crooked pool of some kind in the 1920s and everybody else when to jail and he came out here and chased all these starlets and drank all this booze. His banker called him in and said that he was very nervous about his behavior. He told his banker, “Let me tell you something: my municipal bonds don’t drink.”

The Daily Journal has a lot of assets that aren’t going away just because the people leave. We’re not stupid and we’re not taking the shareholders to zero. At the present time, people like you have bid out stock up to a price where I wouldn’t pay it myself. I don’t do anything about it. I don’t sell because it’s not my nature. I say to myself, well, if you have groupies, you’re going to get this crazy behavior. And – you might even be right. You won’t be right if the software business doesn’t work out very well.  But I don’t think there are that many Daily Journal shareholders in the whole room. This is a different crowd of people. That’s all right – I like you all because you remind me of myself. Who doesn’t like his own image starring back at him? (laughter).

Question: The major banks have trillions of dollars in derivative contracts. What do you think about this – the size and the counterparty risk?

Nugget 14: When a bank is the trusted partner of business and extend credit to people who deserve credit, that’s the most noble activity. Not The Derivatives Hocus Pocus.

Nugget 15: You don’t have to go crazy because you are in banking, but a lot of people do. [Sic: You Shouldn’t Go Crazy, Especially If You Are In Banking.]

Munger: If you intelligently trade derivatives it’s like a license to steal, so you can understand why they all want to do it. Now, it’s very hard to control yourself when life is that easy, and banks have a way of getting into terrible trouble, and I think a lot of them will get carried away by excess. What’s the big plus of having everybody gamble with everybody else? Now you can say that it’s something that will always be with us because of the psychological nature of human beings, but I lived in a world with low gambling for decades when I was younger and I liked it better. I think it was better for the country.  It’s like having thousands of professional poker players. What good are they doing for anybody?

If I were running a major bank I would have less blowup risk, and I would use different methods of determining risk. I would not be in the derivative business at all because I would regard it as beneath me. I like the banks when they get to be the trusted partner of business and extend credit to people who deserve credit. That’s the most noble activity there ever was. I like it when the banks help somebody to buy a car or a washing machine or a truck and they give him an installment contract. Bank of America (ticker: BAC) pioneered all that stuff way early and it was a noble addition to the business activities of the world. But do I like this crazy borrowing on credit cards to finance vacations and so on? I know Germany seems to avoid it and they’re doing fine. I think we slept with the devil when we encouraged this ballooning readiness to consume. It’s a disease to max out every credit card. When I was young the banks didn’t encourage it. Of course, they didn’t make as much money, either.

We owned a bank at Berkshire for over ten years [Illinois National Bank & Trust AKA Rockford Bank]. Our bad debt losses were zero. Our returns on capital were higher than most banks. We never worried for one second, and for anyone who deserved credit, we were glad to accommodate them at fair prices. You don’t have to go crazy because you are in banking, but a lot of people do.

Q: What are your thoughts on BYD [Build Your Dreams, the Chinese battery & automotive company — ticker: BYDDY — an investment of both Berkshire and Munger’s Asian fund]?

Munger: BYD is getting widely recognized as being in some kind of a sweet spot in a world that’s going to have to go to way more electric cars, buses, and taxis, particularly in China. In Beijing, where the average longevity is foreshortened by ten years by air that’s so bad that children are gasping for breath, they have to stop burning gasoline. So far they just have given contracts to big employers who make ordinary automobiles. That can’t last. China is recognizing that when you start killing people in large numbers you have to change behavior. BYD is the only Chinese company that has worked on electrical cars.

The evidence is that the iron phosphate solution BYD has to the lithium battery fire problem is a very safe one. It’s counter-intuitive, because it’s heavy. The people who tried to be light were out of their minds. Imagine Boeing [ticker: BA], to save the weight of two suitcases, going to a lithium battery that was very difficult to control. I’m not an engineer but I would have been smart enough to avoid that one. Even engineers go crazy. The customers want the last two pounds, says the sales department. But the last two pounds are the ones that finally kill you. So I think BYD is in a privileged position and I think it’s likely to be intelligent in adapting to its opportunities.

Q: What do you think of the monetary expansion?

Munger: When you’re as old as I am, you have seen a lot of inflation. I remember buying ice cream cones and hamburgers for a nickel. On the other hand, after inflation the country has done wonderfully. A lot of the people who were the Jeremiahs of that age basically have been proven wrong; the country could stand as much inflation as it got.

On the other hand, I’m not as optimistic as Paul Krugman, whom I always read because he’s the smartest leftist I’ve ever read and he uses the King’s English very well. If Germany had not debauched its currency in response to the reparations following World War I, I don’t think we would have had Hitler. We wouldn’t have had the holocaust. We would have avoided a lot. Flirting around with the debauch of the currency of an advanced civilization on which the whole world depends for its reserve currency, I think we ought to be pretty conservative and not just assume we can print all we want forever, whatever amounts our politicians think is convenient. I was way more afraid than Paul Krugman, but so far he’s been proven more right than a lot of his critics.

Nugget 16: The whole world is better when you don’t reduce engineering standards in finance. We skipped a total disaster by a hair’s breadth.

  1. What do you think of Fannie Mae and Freddie Mac?

Munger: I have a peculiar attitude for a Republican. I think Fannie Mae and Freddie Mac, when they don’t go crazy making lousy loans in response to the demands of politicians, are serving the country pretty well, the way the system is now configured. The fact that we came into it by accident doesn’t mean that it isn’t a pretty good solution. Considering the crisis we had and the risks we faced, everybody behaved pretty well and the result is not awful.

Last time we loosened standards because everybody else was. The politicians hated them, and they couldn’t stand that everybody else was making money on the subprime loans. This was envy and it was stupid. There is nothing wrong with keeping your head when all about you are losing theirs — Kipling was right. Why couldn’t Fannie Mae say, we extend credit to people who deserve credit? Well, it’s not egalitarian enough – we want to shovel money at the people who were deprived. The trouble with that is the whole system blows up. What looks like hard-headedness is really soft-headedness. The whole world is better when you don’t reduce engineering standards in finance. We skipped a total disaster by a hair’s breadth. Partly because both Democrats and Republican administrations, both Congress and the President, made decisions that were pretty much exactly right and did it under terms of terrible pressure. I’m a big fan of the people who took us through the crisis. I’m not a big fan of the people who caused the crisis. Some of them deserve to be in the lowest circle of Hell – not that I have any power to put them there.

Nugget 17: If somebody asks you to do something that’s bad enough, you can give up your damn job rather than do it.

Q: But what about when the government stripped away the profits of these enterprises?

Munger: They were private corporations with a little bit of government image and they were insolvent at the time. I don’t think it was unjust. They had behaved terribly. If somebody asks you to do something that’s bad enough, you can give up your damn job rather than do it. Fannie Mae did not have to cave. It was run by people who were cavers by nature. They were just looking for a place to sell out for personal advantage. That’s what they did in life.

We want more people who say, “You’re my boss, and if that’s what you want to do, you’ll have to get a different errand boy. I’m not going to do it.” There ought to be way more of that. Elihu Root, probably the greatest cabinet officer we ever had, said one of my favorite comments: No man is fit to hold public office who isn’t perfectly willing to leave it at any time. Of course, he was the most famous lawyer in the world so he could immediately leave to success, whereas the other politicians, if they left, were nothing. The country would be better off if we had more people like Elihu Root making the decisions.

Q: What are you going to do with the technology companies at Daily Journal? Is there some thought to integrate the three brands?

Munger: We’re going to integrate them as fast as reasonably practical. We’ve already started. Exactly what the timetable will be I can’t tell you. One of them, ISD, was a very low risk transaction because they had contracts in place that would give us back most of our money. The other [New Dawn Technologies] was a real gamble: we basically paid $15MM-$16MM for a company with a net worth of about zero. We did that on a venture capital basis. I feel better about it now than when we did it. I’ve had an uneasy moment or two between then and now but now I really like the way it’s working out. I like the people, I like the ethos, I like the people who are gone (I mean I like them being gone), and I’m glad we did it. I think I know more about it than our accountants do.

  1. How much investment risk did you take personally once you had made enough money to live well?

Munger: Most of the Munger money – I don’t count the Daily Journal, it’s just a little asterisk (laughter) — is in Berkshire Hathaway, Costco (ticker: COST), and an Asian fund. Now, you could go to the rest of finance, they think they know how to handle money, and they’d say it’s totally unthinkable, Munger doesn’t know what the hell he’s doing. Doesn’t fit our models. But I’m right and they’re wrong.

If you’re shrewd enough to choose well, three holdings – any one of which would support your family in perpetuity — is enough security. What difference does it make if somebody else in some year goes up 10% and you go down 5%, when you’ve got 1000 times more than you need anyway? The people who make these crazy decisions don’t actually have envy: what they have is clients who will fire them if they don’t get the same results as everybody else. That is a crazy system. Everybody gets on the same merry-go-round. I never had any interest. As I sit here, all my securities are making new highs every day. Am I doing it wrong?