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Wisdom Pick 7. In a poker game, best players like complicated games because they make it easier to beat the less skilled. It’s the same in finance.
Wisdom Pick 8. When a guy is offering you free money, don’t listen to the rest of the sentence” – Munger’s Rule.
Charlie knows a poker game where the best players like complicated games because they make it easier to beat the less skilled. It’s the same in finance. Too many Caltech grads are going into finance. But in finance you clobber your own customer by being cleverer. For example, in Korea and Mexico, investment bankers sold ordinary businesses currency derivatives that made a little money usually, but eventually blew up. “When a guy is offering you free money, don’t listen to the rest of the sentence” – Munger’s Rule. It’s a mistake to unethically rook your own customers; we won’t miss it if it’s curtailed.
A lot of this happened because accounting failed. For example, the derivatives book Berkshire acquired was said by the accountants to be worth something positive, but the reality turned out to be negative $400 million. We don’t need mark-to-model accounting.
Wisdom Pick 9. There is too much math in accounting and not enough horse sense.
There is too much math in accounting and not enough horse sense. For example, over and under-reporting assets look equally bad mathematically, but over-reporting is much more dangerous. Lower-of-cost-or-market valuation sometime caused under-reporting, but letting people mark assets up causes real trouble. Charlie gave the example of the Morgan bank switching to allow trades to be marked up, because, they said, their traders would leave if they didn’t. The explanation was honest, but the attitude was crazy.
You can look at major banks’ balance sheets and see hundreds of billions of dollars of uncleared derivatives. It’s like hydrogen and oxygen sitting by the roadside, waiting for a flame.
Wisdom Pick 10. An Example To Cheer
Is there any example to give us cheer? Yes, Lee Kuan Yew of Singapore. The average guy in his ethnic group married a pretty but less intelligent woman; Lee, however, noticed one who was slightly smarter than he was, and married her. His son is now prime minister. Lee drained the malarial swamps without worrying the effect on some little fish, fined people with stagnant water in their back yards, and got rid of malaria. To solve the drug problem, he looked around and found the solution in the US, of all places. He copied our military: urine tests at any time and mandatory rehab on failure. His policy was to check hard anything that might grow like cancer. If you tried to start a gang, your fifth or sixth recruit would turn out to be in the secret service. It led to prosperity. It was paternalistic, but we need more attention to his model. Singapore doesn’t have 100% free speech; it’s a crime to insult the ethnic Malay minority. Charlie thinks Lee’s Singapore has had a positive influence on China. They saw the Cultural Revolution wasn’t working and were impressed by what they saw in Singapore. Charlie wishes we were more like Singapore; “in many respects we’re too damn permissive.”
Wisdom Pick 11. Permissive accounting led to Enron booking twenty years’ projected future profits as an asset.
Permissive accounting led to Enron booking twenty years’ projected future profits as an asset. We have to say no. Another accounting example is setting reserves for banks by actuarial techniques: When there’s a boom on, there are no losses on loans, so you let your bad debt reserve go to zero just when it should be building up most—insane. You have “mathematical consistency,” but it makes no sense. Yet another: When all your creditors are scared, with good reason, that you’ll go broke, and are willing to sell your debt for forty cents on the dollar, you now get to book a huge profit, even if you have no cash to actually buy the debt in. Some of our better leaders like Jamie Dimon are complaining about accounting standards— actually, only him. “My hat is off to him,” but I’d take away his derivatives book if I could.
Wisdom Pick 12. By the way, some investment banks actually bought casinos; “why run a casino in drag if you can run a real casino?”
By the way, some investment banks actually bought casinos; “why run a casino in drag if you can run a real casino?” But a casino isn’t a useful thing, although it’s a great business, and running a bank as a casino avoids the fixed assets and restrictions on location that apply to real casinos.
Source: http://www.valueplays.net/wp-content/uploads/The-Best-of-Charlie-Munger-1994-2011.pdf