Copper stays low for decades and we finally get a shortage of it, and all of a sudden it’s in the stratosphere. I’ve seen housing prices collapse when the population is leaping. Once prices start galloping, people buy real estate like they buy stocks in Saudi Arabia or Kuwait – because they’re doing up. A whole class of day traders became condo flippers. It really happens – thousands of them. But you always have stock markets where prices stay low for long time. This is good for people like you. This is why you can afford to fly long distances to come to Pasadena [to hear me and learn about value investing].
Learn at the Temple of Rationality
All you have to do is keep trying to learn at the temple of rationality and do things [when it makes sense]. I’m quite prosperous even though I didn’t invest in K-Mart’s bankruptcy. You can miss a lot. We bought 4% of Freddie Mac [many years ago] yet none of Fannie Mae. How could the same mind have done that?! It wasn’t very smart. But despite the many cognitive mistakes [we’ve made], we’re a lot richer now than we were then. I think you need to constantly remember the mistakes of omission. We’re very good at this. Nobody remembers them – nobody thinks less of me for missing Kmart – but I think about it every day. It’s a very [useful discipline to have].
Chris Davis [of Davis Advisors], who’s not here, has a temple of shame for mistakes. [It’s a wall in his office in which he hangs stock certificates of the worst stocks he’s ever invested in.] But this is inadequate. You need the temple of shame squared – great things you almost did and, had you been a little more rational, should have invested in. You’ll be a lot better investor if you do this. You ought to remember boners of both kinds. Reality doesn’t distinguish – either way, in 10 years, you’re poorer. So why not celebrate your mistakes in both categories?
Point 32. Efficient Market Theory – People Believe In Flat Earth
We didn’t get any courses [on value investing] into [the curriculums of] major universities for the first 30 years [in which investing was taught], but it’s shifted a bit in the past 10 years. The flat earth people [meaning the believers in the Efficient Market Theory] are only now about 75-80% [of the faculties].
Point 33. Beware Of Derivatives, Beware Of Silver-Tongued Salesmen With Wonderful Slide Shows
RISKS IN THE FINANCIAL SYSTEM
Derivatives and Accountants Selling Out
This world of derivatives is another place the world has gone absolutely bonkers by the standards of the past. You take Fannie Mae – a big, clumsy, dumb bureaucracy to start with – and they’re in this great privileged position where they got enough of a government halo so that their borrowing costs were lower than other people’s. And they created this marvelous intermediary system where they were able to take an override on the safe mortgages of the world. They could raise earnings 20% per annum for a decade or so, but that wasn’t enough. They wanted to make sure that they earned 15-20% every quarter than they earned in the previous year’s quarter. And so they listen to the siren song of the professionals who invented these mad derivatives. And of course there was a lot of leverage in the bargain.
When they tried to clean up Fannie Mae, the new CEO complained that spent hundreds of millions of dollars on experts just trying to understand what’s already on the books. You get people investing weird things, complex things for other people to gamble in. And those silver-tongued salesmen going into leading institutions, with wonderful slide shows showing how everything’s going to work way better for them – weird things get done.
What happens, of course, is that the same derivative trade that’s put on, the accountant for Firm A says that the firm made $8 million, and the accounting firm for firm B says its client also made $8 million, and it’s the same trade. I’ve never met anyone in the accounting profession that’s bothered by this. They go around and check to see if the retailer owes some money to a wholesaler – they want to make sure that it’s the same on both sides. But on derivatives, the accounting profession has sort of given up – it gets complicated. I don’t think given up is the right word: They sold out. You’d think they’d learn by now and put more integrity into the system. But telling people to do something unpleasant when they’re making a lot of money out of it…it’s too hard. I likened it in some previous discussion to what doctors have to do when someone’s on life support.
Point 34. Tough Decisions Are Tough
The religions of the world say it’s perfectly alright to withdraw the tubes – you can withdraw artificial help. But when you do it and the patient shrivels up like a prune, the guy who pulls the tube out feels like a murderer. He’s not – it’s the correct thing – but that’s what he feels like. I think that’s the way the accountants react to the situation when $8 million of profit is being booked by each side of the same trade. He can’t pull this plug. He doesn’t want to think about the consequences.
Maybe there’s some more kindly explanation. [Laughter] I’ll give our accountant [who was sitting on the stage next to Munger] the opportunity if he wishes to participate in this discussion and explain why the accountants are doing what they’re doing. [Short pause] He says he has nothing to add. [Laughter. (That’s Munger’s oft-repeated line from the Berkshire Hathaway annual meeting.)]
Point 35. Some Derivatives Asset Are “Good Until Reached For”
More on the Risk of Derivatives
I regard the counterparty risk as extreme. But no-one cares about this because the accounting statements assume it away. If you look at the trading sheets on Wall Street, there’s no line for counterparty risk. The person who is supposed to think about this would be very unpopular [if he tried to add this]. Pulling away the punch bowl at the party has never been a way to prosperity and popularity.
If you look at derivative markets enough, you think it was scandalous. That doesn’t mean it can’t go on for a long time, however. Look at Japan. Great civilizations can withstand a lot of terrible behavior. It’s a good thing. Lord knows, we’ll need it.
Look at Berkshire’s Gen Re derivative book. It was valued at $400 million on the balance sheet [but when he reached for the money, it wasn’t there]. Imagine an balance sheet item labeled: “Asset – good until reached for”! [Laughter] [My comment: In fact, Berkshire has taken hundreds of millions of dollars in losses as it’s run off this derivatives book – during a benign time in the markets, when no-one else was trying to run off their book! Can you imagine the utter chaos that would ensue if, say, JP Morgan Chase tried to run off its $40+ trillion derivatives book?!]
Final Comments on Derivatives
If we have a hell of a mess due to a big derivatives blowup, the country will survive it. Did we need derivatives to get to their current huge size? [Of course not.] [People argue that because] it lays off risk, it therefore it must be wonderful. That is not the Munger mindset. If you’re lucky, we’ll see who’s right.
Pointer 36. Ballooning Consumer Debt Is A Danger. (See South Korea Experience)
There’s no question that huge ballooning credit practices in other places have caused crashes. For example, South Korea had a huge crash from irrationally ballooning consumer credit. But I can’t predict whether the troubles I foresee will come soon or later. All I can predict is that there is considerable danger.
Notes from 2006 Wesco Financial Annual Meeting – By Whitney Tilson