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

73. Wesco Financial Annual Meeting 2005: Lessons Learned – Part 6 – Points 31-36

Point 31. McDonald’s Is a Great Educator. I think a lot of what goes on there is better than at Harvard.

I get flack for saying [when I visit a college and give a speech], “This is a nice college, but the really great educator is McDonald’s.” They hate me for saying this and think I’m a slimy creature. But McDonald’s hires people with bad work habits, trains them, and teaches them to come to work on time and have good work habits. I think a lot of what goes on there is better than at Harvard.

I’ve never examined AIG in great detail. AIG was run by a truly brilliant, dominant personality for a long, long time and had a fabulous record. I don’t think we’re going to find a fraud like Enron. Rather, a good company with a chieftain that maybe gilded the lily. I think he thought it was his duty to help along the reputation of AIG. I think he thought it deserved a better reputation than it had. I agree. I think every corporate chieftain feels the same way. I don’t think it’s blue smoke and mirrors.

I will miss Hank Greenberg dearly in areas like tort reform. He was always honest with us. He invited us or we invited him in the deal to buy the assets of Long Term Capital Management. There’s a lot that was strong and good at AIG.

AIG, GE Credit and the Risks of the Carry Trade

That said, it’s a lot like GE. It is a fabulously successful insurance operator, and with success it morphed into a massive carry business: borrowing a lot of money at one price and investing it at another price. AIG was a big operator that was a lot like GE Credit We never owned either because even the best and wisest people make us nervous in great big credit operations with swollen balance sheets. It just makes me nervous, that many people borrowing so many billions.

Point 32. What’s wrong with someone getting a little richer than you? It’s crazy to worry about this.

As you can tell in our operations, we are much more conservative. We borrow less, on more favorable terms. We’re happier with less leverage. They’ve been successful, but we’re too chicken to join them. You could argue that we’ve been wrong, and that it’s cost us a fortune, but that doesn’t bother us. Missing out on some opportunity never bothers us. What’s wrong with someone getting a little richer than you? It’s crazy to worry about this.

There’s a lot of leverage in those carry-trade games. Other people are more certain than I am that aircraft can always be leased.

Point 33. A small leak can sink a great ship.

Point 34. We would do some very unpleasant things to prevent something that would have very bad consequences far into the future.

I would never short a company that was doing $180 billion [in sales] per year with a market cap of $15 billion that was such an iconic part of America. I would never dream of making that short. What happened was that a lot of very decent people running GM basically blew it. They were facing a very serious competitive challenge and they set up a [lifetime healthcare and pension] system that will grow and grow and grow and they are paying one hell of a penalty.

Employees have 5-6 times the value in their pension plan than all of the stockholders combined. [At the time, GM had a market cap slightly above $15 billion vs. approximately $90 billion set aside for pension liabilities.] GM gave all of the value of the company to employees and left shareholders with almost nothing. They didn’t observe the maxim that a small leak can sink a great ship. They never should have allowed the unions to bargain with each company and shut one company down and let the other two take share. They should have bargained as a unit. The result today is a combination of what they gave away one year at a time.

I regard GM as such a marvel of human achievement, but also an example of massive management failure. I can’t be criticized if I eventually die – I delayed it as long as I could. GM delayed it as long as they could. They had a very tough hand to play, but I would argue that they blew it.

I don’t think Berkshire Hathaway will blow its hand in this way. It would never do that. We would do some very unpleasant things to prevent something that would have very bad consequences far into the future.

Nuclear weapons are a very serious problem. [It’s so awful to contemplate that] people use gallows humor. What would you do if you were told a nuclear bomb would be detonated over Pasadena right now? The answer: you’d crawl under the table and kiss your ass goodbye. (Nervous laughter)

Point 34: Sometimes You’ve Got To Say “Include me out.”

We regard the Leucadia people as very smart. Is it conceivable that the Leucadia people could have one outcome that didn’t work very well?

Sure, it’s possible. I look at telecom and all the change and my reaction is that of Samuel Goldman: “Include me out.” I’m just not suited for this; I don’t know how to predict those outcomes, so I leave it to other people.

Point 35. Extending high-cost credit to the least able people is possible in a free market but that doesn’t mean it’s honorable.

It is weird the way that capital occurs. We have monetized houses in this country in a way that’s never occurred before. Ask Joe how he bought a new Cadillac [and he’ll say] from borrowing on his house. We are awash in capital.

[Being] awash is leading to very terrible behavior by credit cards and subprime lenders -a very dirty business, luring people into a disadvantageous position. It’s a new way of getting serfs, and it’s a dirty business. We have financial institutions, including those with big names, extending high-cost credit to the least able people. I find a lot of it revolting. Just because it’s a free market doesn’t mean it’s honorable.

Point 36. Social Security Is Amazing

I’m not so sure that common stocks will do wonders. In England, where they tried to create a scheme like this, they let the brokers and salespeople loose on the people and it was a disaster. So they [those in the U.S. who are pushing to allow people to invest their Social Security savings themselves] said, “We won’t do that. We’ll just package them in index funds.” But the way it’s set up, it’s like an arbitrage. A guy gives up the promise of Social Security to take the promise of an index fund.

Social Security is amazing how we’ve run it. It’s inflation protected. It’s easy to sneer at it, but it’s one of the most successful government programs ever. It’s low cost and encourages work.

People say if you never change the revenue base, it’ll run out of money. But if 10 years from now, the country is 30-40% richer, why not use a higher percentage of GDP to pay people? Young people benefit too – the money is paid to people who might be moving in with them. (Laughter) Everybody’s going to get older, but also richer, so why wouldn’t you spend a higher percentage of GDP on them? Why is that so unthinkable? I’ll tell you what’s unthinkable: that so many people are that stupid! (Laughter)

http://www.valuewalk.com/wp-content/uploads/2014/05/Charlie-Munger-2005-2013-minus-Harvard-Westlake.pdf

Notes from 2005 Wesco Financial Annual Meeting – May 4, 2005 – By Whitney Tilson