Investment Wisdom

111. Wesco Annual Meeting 2010 – Part 1 – Wisdom Pick: 1-6

Excellent Book: Charlie Munger For All Seasons

Wisdom Pick 1. Because running a big firm living on a small spread is “very precarious if you’re ambitious.” The same problem exists on Wall Street.

Wesco 2010 Meeting Notes, Part I.  The meeting was called to order at 1:57, the nominees for director were elected, and the meeting was adjourned at 2:02.

Charlie then announced that he would follow the same format as last year, in which he’d “prattle” for a while before taking questions from the floor, except that this time he wouldn’t ask himself questions. “I’m of course flabbergasted that we have so many people coming to Pasadena after Omaha”; obviously we “have some addicts out there.” He will aim to cover matters not covered in Omaha.

Wesco’s market cap has grown from $20 million to $2 billion under current management, a “failure” compared to Berkshire but pretty good compared to other things, especially to almost every other California savings and loan; virtually every other S&L “went blooey.” Why? Because running a big firm living on a small spread is “very precarious if you’re ambitious.” If you pursue 10 to 12% growth, you’ll take your institution into ruin. Your competition will make bad loans, and you’ll either have to fire people and cut back or join the race to the bottom. It’s like Greek tragedy. The same problem exists on Wall Street.

Wisdom Pick 2. “If your way of making a living depends on X, it’s hard to convince yourself of non-X”

Why is there no better system for preventing ruin due to deteriorating asset quality? Because wealth leads to power which leads to political influence and bad audit standards. “We were on the edge of something deadly serious.”

Why can’t we get the “peace process” right after the financial blowup the way we got it right with the Marshall Plan after World War II? Because “our elites failed us.” Academia is still teaching failed financial ideas. Charlie has thought about why some high-IQ people make bad decisions while other make good ones. “If your way of making a living depends on X, it’s hard to convince yourself of non-X” (which he attributes to Upton Sinclair). To be in the “sane minority,” you have to practice right decision making just as you practice making the right swing in golf.

Other folly: Diversification (“diworseification”)—it can avoid disaster, but it can’t find success; beta—low beta won’t cause success either. Charlie pointed out Li Lu in the audience as someone who liked business school but didn’t learn much there, except when Buffett gave a lecture. What we do at Berkshire is very difficult and therefore hard to teach. Business schools fail by teaching what is easy to teach but less useful. Going back to teaching business history as Harvard used to would be good; there’s a lot to be learned from the rise and fall of GM, or the rise/fall/rise of railroads.

Wisdom Pick 3. On Difference Between Theory & Practice

Charlie told the story of a friend who learned in business school to prosper by abusing his suppliers, driving up their working capital while driving down his own—it was simple algebra. On the exam, he gave the math the prof wanted but said it was asinine; in the real world he’d want his suppliers to prosper and be happy. That’s how he behaved in the real world, and to say he prospered himself is a gross understatement.

A second anecdote about a friend: Guilford Glazer. Back from the war, he was admitted to Harvard Business School, but his father’s machine shop was struggling, and he asked for a year’s deferment to help out, which was granted. A year later, he asked for a second deferment. The Harvard guy asked, “How many employees did you have a year ago?” “Fifty.” “And now?” “Nine hundred.” “I don’t think you need to come to our school. Why not just stay where you are, and come by later and endow the place.”

Wisdom Pick 4. In Soccer As In Investment Banking, You Need Referees

Guilford’s father gave him some advice relevant to recent events: only sell things that are good for the customer. He took the advice, and is now a billionaire. Soccer is also relevant: In soccer, it’s hard to win if the other team has a really good player. If you let players do what they want, they’ll “work mayhem” on the other team’s star, so you have referees running up and down the field to limit the mayhem. It’s the same with other highly competitive people like investment bankers; you can’t expect them to rein themselves in, so it’s government’s role to referee. “At its peak, something like the Lehman firm just before it went under was pathological,” “like the worst boiler-room operators,” far from Guilford’s father’s advice of selling people only things that are good for them. The people who did this mostly blame others for the bad results.

You need a referee; yet FannieMae and FreddieMac had 200 people at OFHEO to supervise them, and “right under the nose” of OFHEO they went bust and used phoney accounting to juice the executives’ bonuses. It’s not enough to have a regulator refereeing; there’s co-option of the regulator, or simple bureaucratic inertia (as with Madoff and the SEC), and there’s no point giving more authority to such regulators. So you must curtail the activities that are permitted. Not everybody can be trusted to do what Goldman Sachs does, so it must be curtailed—and Goldman Sachs must share in the curtailment. It was done in the 1930s, and it worked.

Wisdom Pick 5. We don’t need the capital allocation of civilization to be mixed with a casino. We need to separate commodities and derivatives from investment banking.

We don’t need the capital allocation of civilization to be mixed with a casino. We need to separate commodities and derivatives from investment banking. Underwriting, running margin accounts for hedge funds, advising, commissions, spreads—there’s a lot of legitimate activity for investment banks to do; they don’t need to do everything else. They could spin off the people and capital associated with other activities; there would be no big hardship involved.

Wisdom Pick 6. Some Things Gets Better With Age

Charlie digresses to comment that it’s hard to sit up here in his 87th year. It reminds him of a story about George Burns, late in life, receiving a singing telegram featuring four beautiful girls. “I’m sorry,” he said, “but I’m afraid that one of you will have to come back tomorrow.”

The referee needs to say, If you’re going to be backstopped by government credit, there’s a whole bunch of stuff you can’t do; otherwise you get Lehman.

On Goldman Sachs: they have the “best morality and wisdom” among the investment banks, and Charlie doesn’t like the government jumping on them, although he doesn’t think they’re doing it to be “asinine” on purpose but just stumbled into it.