Munger on Reform, Pain, Leveraged Speculation
Great quote this morning in WaPo from Warren Buffet’s better half, Charlie Munger:
“Sensible reform cannot avoid causing significant pain, which is worth enduring to gain extra safety and more exemplary conduct. And only when there is strong public revulsion, such as exists today, can legislators minimize the influence of powerful special interests enough to bring about needed revisions in law.
Many contributors to our over-the-top boom, which led to the gross bust, are known. They include insufficient controls over morality and prudence in banks and investment banks; undesirable conduct among investment banks; greatly expanded financial leverage, aided by direct or implied use of government credit; and extreme excess, sometimes amounting to fraud, in the promotion of consumer credit. Unsound accounting was widespread.
There was also great excess in highly leveraged speculation of all kinds. Perhaps real estate speculation did the most damage. But the new trading in derivative contracts involving corporate bonds took the prize. This system, in which completely unrelated entities bet trillions with virtually no regulation, created two things: a gambling facility that mimicked the 1920s “bucket shops” wherein bookie-customer types could bet on security prices, instead of horse races, with almost no one owning any securities, and, second, a large group of entities that had an intense desire that certain companies should fail. Croupier types pushed this system, assisted by academics who should have known better. Unfortunately, they convinced regulators that denizens of our financial system would use the new speculative opportunities without causing more harm than benefit.”
Uncommon common sense . . .
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Source:
How We Can Restore Confidence
Charles T. Munger
Washington Post, February 11, 2009; A19
http://www.washingtonpost.com/wp-dyn/content/article/2009/02/10/AR2009021003122.html
February 11th, 2009 at 12:54 pm
There’s that damn moralizing word again! Some people on here just ain’t going to like that being a cause of the problem, let alone possibly part of the the fix. Morals and ethics, just an intangible concept!
February 11th, 2009 at 1:01 pm
Munger is correct that “Sensible reform cannot avoid causing significant pain, which is worth enduring to gain extra safety and more exemplary conduct”. But Americans don’t want to take responsibility (pain)for their actions, though certainly want others to take responsibility for their actions. And politicians think it is their job to prevent pain. Thus we will likely muddle through this mess for quite a while.
February 11th, 2009 at 1:05 pm
Following on from Willem Buiter’s article last week, it is clear that the sources of this crisis has a morality aspect.
This will help to restore confidence – the FBI is investigating >500 cases of corporate fraud. Let us not lose all faith in the institutions of this country, at least not yet.
http://news.yahoo.com/s/ap/bailout_fraud;_ylt=Atlp4PAk1OkN170qXWhG2RCX.aF4;_ylu=X3oDMTE2YnQ5b2I3BHBvcwMxBHNlYwN5bi1yLWItbGVmdARzbGsDLWZiaWludmVzdGln
February 11th, 2009 at 1:07 pm
he is saying what all reasonable already understand- that “the bankers” leveraged the system to their benefit until it collapsed. I believe their was massive fraud and mismanagement at all levels of the banking industry (and credit agencies) that demands accountability- this includes huge and punishing civil penalties and possible prison time. That is the only way to keep greed and sense of entitlement in check.
February 11th, 2009 at 1:14 pm
Morals and ethics are the very basis of free market capitalism. Without those “intangible” concepts, we’ve got no trust or confidence and therefore the system does not and will not work.
February 11th, 2009 at 1:22 pm
“And only when there is strong public revulsion, such as exists today, can legislators minimize the influence of powerful special interests enough to bring about needed revisions in law.”
In other words, only when the proletariat threaten revolution will a few bones to be tossed to the rabble.
February 11th, 2009 at 1:38 pm
@ahab- so, all the jail time given in the early 2000’s to Worldcom, Enron, Tyco, Global Crossing, etc. executives was just too long ago? Obviously things that happened in this decade were too long ago for ‘the bankers’ to remember.
I guess the only cure for massive greed is massive poverty, which will hopefully happen to our banker friends.
February 11th, 2009 at 1:39 pm
Doesn’t Geithner’s plan call for the use of leverage to buy toxic assets?
February 11th, 2009 at 1:43 pm
@ ndmaster
good point- it’s that sense of entitlement that does all these types in- that they are special and deserving of what they skim off everyone else- in many cases causing great harm to individuals and society in general. We still need to claw back the bonuses with penalties and fines.
February 11th, 2009 at 1:44 pm
I have somewhat mixed feelings about Munger’s comments, but I do agree that things were pretty much allowed to run amok. The fix for such a problem has very little to do with money and virtually nothing to do with taking taxpayer’s future labor and propping up the offending institutions. You cannot restore trust with money and government can never do it with other people’s money. What our government owes us today is not a continuation of the looting. What they owe us is some of the work that we’ve elected them to do and that we are paying them for. We need prosecutions, we need reorganization, we need a redefining of institutions, we need application of the regulations already in place. Beyond that what we need from them is that they help all the individuals and families who get caught up and hurt by things beyond their control.
We also need them to understand that banking springs from a strong economy, not the reverse.
February 11th, 2009 at 2:14 pm
wally: “We need prosecutions, we need reorganization, we need a redefining of institutions, we need application of the regulations already in place.”
Don’t be ridiculous. These people are all friends, relatives, colleagues, summer house and yacht sharers (if they don’t have their own), etc.
February 11th, 2009 at 2:17 pm
Here’s a quote from a news article:
“The panel’s top Republican, Spencer Bachus of Alabama, said the bankers and Congress will have to do their part to sway people by “winning back their trust and their confidence.”
What’s wrong with this? Here’s a Congressman who thinks these people ever had the trust of the public in the first place! They never did and so they cannot “win it back”. These people have to go – preferably to prison, but at least out on the street.
February 11th, 2009 at 2:19 pm
DL Says:
February 11th, 2009 at 1:39 pm
Doesn’t Geithner’s plan call for the use of leverage to buy toxic assets?
Of course. And it is the same business model as the ibanks (and actually all banks everywhere) employ: Borrow short to lend long. W/ T-bills at less than 1%, the government increased their percentage of borrowings in them from 20 to about 30% of the total (relative to bonds). Of course, since none of the “investments” purchased with these borrowings are anticipated to be paid back any time soon, the gov must roll over its short-term debt regularly. The inability to do so brought low Bear Stearns, Lehman, AIG, the various SIV failures, Countrywide, the Term Auction Facilities market, etc.
No worries, though. Mismatched maturities don’t matter to the folks that print the dollars. It might ultimately matter to the folks that use dollars as a medium of exchange, store of value, etc., but the government will always be able to roll over its debt (it prints the currency in which the debt is denominated). Whether it will thereby destroy the dollar and further collapse the credit markets in doing so is another matter entirely.
February 11th, 2009 at 2:29 pm
Complicity.
http://news.yahoo.com/s/ap/20090210/ap_on_bi_ge/sec_enforcement_chief_resignation
When I read the comments by Munger and then the subsequent comments of other readers of this blog, one word comes to mind. Complicity. The egregious behavior which contributed to or made inevitable this disaster was IMPOSSIBLE without the full-throttle complicity of government agencies. Active complicity.
Linda Thomsen is one of many Americans who willingly did the bidding of the criminal cabal which had ensconced itself in the WH. But she is not the only one. There are millions of fellow Americans who prefer easy money and dishonour over work and earned reward.
As we move from abundance to scarcity of goods and capital we will see a surfeit of debt and complicity.
Which reinforces a core belief of mine: God is Irony.© (too late I already copyrighted this and tattooed it on my forehead as proof.)
Complicity only breeds in the shadow of cowardice- seems like there’s been plenty of that too.
February 11th, 2009 at 2:42 pm
God is Irony.©
I’ve always figured He was logic, but the underpinning of all irony is logic, so…
February 11th, 2009 at 2:54 pm
Ya can’t copyright a short phrase. You can use it as a TM, though.
You can copyright a book!
— from a few threads down —
BR don’t forget the Kindle, very low cost of transmission.
cjc
February 11th, 2009 at 3:11 pm
Jesus- why in God’s name did I tattoo it on my forehead?
February 11th, 2009 at 3:37 pm
This from Bloomberg today…
“Feb. 11 (Bloomberg) — Since Duncan Niederauer took over NYSE Euronext 14 months ago, he has stopped market share losses, devised a plan to generate additional revenue from derivatives trading..”
Someone, SOMEONE, needs to stop these guys! They can create trouble in an order of magnitude faster than the feds (or anyone else) can remedy it. Let’s get to the root of the problem. Stop this business and unwind their positions. Let these genius’ get a real job producing real goods.
February 11th, 2009 at 3:54 pm
Good point, but conspicuous by it’s absence is any reference to Munger’s buddy’s rating service Moody’s which provided the lubricant in this huge screwing.
February 11th, 2009 at 3:55 pm
I hear what he is saying and it makes sense but I still thing it dances around the problems without stating the rather obvious solution:
The solution isn’t obvious, you might say. It’s also complicated.
I disagree.
The PROBLEM:
Corporate personage = limited liability = limited accountability = no risk in betting other people’s money on the default of assets you don’t own (i.e. naked credit default swaps).
the SOLUTION:
Honor the law of contracts. The person signing the document shall be held liable for the economic consequences. The person shall not be entitled to sign said contract unless he has 100% secured collateral (no, ifs, ands or buts). No “I’m the CEO or CFO of XYZ Corp. dodge allowed.
Yeah, I know. That’s too abvious. We need to keep things nice and complicated so business schools and law schools can justify the tuition. What incessant bullshit!
February 11th, 2009 at 4:06 pm
And another thing:
LEVERAGE! We really need too get back to calling BORROWED MONEY a LOAN! Otherwise the financial shysters will continue glorifying the use of fiat collateral. Fractional reserve banking is bad enough, but to get fund mangers and brokers in on the “money multipliers” is the path that led us to this insane insolvency. It’s also the one thing that nobody in finace wants to talk about. It’s their candy. It’s the gift that keeps on giving. It’s the device no working person can have. It’s the ability to multiply your capital through sleight of hand. We continue to allow this and we are done, period.
February 11th, 2009 at 5:31 pm
The problems will be dealt with, but the odds that responsible solutions will be adopted straightaway are *very* slim — just as it took a number of years into the Great Depression before they began to legislate the end of the “bucket shops”, to erect the firewalls between the banking and brokerage industries (e.g., the Glass-Steagall act), and implement a laundry list of other regulatory controls that tried to keep the markets free of corruption and fraud.
Now we have deconstructed those firewalls, and have our own “bucket shops” in the form of the CDS market, completely free of any audits or regulation, and behaving just as badly as the bucket shops of the 1920s, but with trillions instead of millions of dollars at stake.
The mortgage markets have been perverted into a harsh parody of anything resembling secured loans, with fraudulent appraisals, no income verification, easy money, and securitization of the resultant mortgages, making use of the injected risk by slicing and dicing mortgages, bundling tiny slices of them into CDOs of various levels of presumed risk, bearing different interest coupons. Of course, nobody guessed that every player in the game was bent, and the entire edifice would come crashing down, rendering half of the CDOs as worthless, and making it impossible to tell the good ones from the bad.
It will be quite a while before there is any light at the end of this tunnel — but that does not preclude the possibility of significant market moves in either direction, as we proceed upon the overall downward path to second-class nation* status, crushed by a debt load that will not be lightened for decades.
But Charlie Munger is delusional if he thinks that serious bipartisanship can emerge from the cesspool of crooks that reside in the House and Senate. It will take at least a couple of election year flush cycles before anything resembling bipartisanship can emerge.
*(I may be optimistic here)
February 11th, 2009 at 6:04 pm
Munger is too smart to perpetuate the ridiculous analogy between trading CDS and betting on horse racing. Trading CDS is no more “betting” or “gambling” than trading stocks – the only difference is that with stocks and most other asset classes there is oversight to make sure both parties have the means to settle the trade.
In reality, horse racing probably has MORE oversight than CDS – i’m guessing i can’t walk up to the window at Churchill Downs and throw down a few hundred thousand on the three horse without showing them the money up front…
but the problem isn’t these dastardly derivatives contracts – the problem is the margin (or lack thereof) that accompanies then.
February 11th, 2009 at 6:29 pm
Corrections:
1) “…undesirable conduct among investment banks;”
Corrected: criminal conduct among investment banks;
2) “…and extreme excess, sometimes amounting to fraud, in the promotion of consumer credit.”
Corrected: and extreme excess, characterized by ubiquitous, blatant, systemic fraud and usury, in the promotion of consumer credit.
3) “Unsound accounting was widespread.”
Corrected: The total abandonment of accounting principles was required of accountants as a condition of continued employment or in exchange for a percentage of the take.
4) “There was also great excess in highly leveraged speculation of all kinds.”
Corrected: There was leveraged dealmaking allowing the criminal perpetrators to skim the revenue stream using pseudo-legitimate methods disguised as fees and bonuses.
5) “This system, in which completely unrelated entities bet trillions with virtually no regulation…”; and. “…unfortunately, they convinced regulators that denizens of our financial system would use the new speculative opportunities without causing more harm than benefit.”
Corrected: From the highest levels of government, regulators and law enforcement officials were encouraged to look the other way while individuals, investor groups, and foreign countries were defrauded, and our treasury was looted defrauded. those refusing to comply with and/or participate in this continuing criminal enterprise were summarily black-balled and/or dismissed on trumped-up charges.
_______
I’ve been saying it for a number of years, and it’s still true: The entire collapse of our financial system is a law enforcement matter. The damage is done, it is irreversible, the guilty must be punished. Anything less, and we will live to see this happen again.
February 11th, 2009 at 6:30 pm
Sorry for the typos.
February 11th, 2009 at 6:41 pm
I agree wholeheartedly, Marcus. Well put. I’m hoping that there will be several perp walks in due time. The wheels of justice move slowly, or at least that’s what I’m hoping. They can’t just sweep this mess under the rug and hope that we recover from this epic mess without any accountability/repurcussions to those who caused it. This isn’t merely a “morality play”, it’s also about restoring our system.
February 11th, 2009 at 11:06 pm
American’s, like all people, can endure pain and sacrafice. It is when such is not endured equally by all that things get nasty, i.e., bank bailout without sufferring.
February 12th, 2009 at 11:42 am
Munger is too smart to perpetuate the ridiculous analogy between trading CDS and betting on horse racing. Trading CDS is no more “betting” or “gambling” than trading stocks – the only difference is that with stocks and most other asset classes there is oversight to make sure both parties have the means to settle the trade.
IIRC in the article he referred to CDO traders as “bucket shops”, which just made my whole day. That, and finding a used driveshaft for my bike…
Charlie Munger for Treasury! Volcker for the Fed!
February 12th, 2009 at 12:54 pm
@ AGG @3:55
The PROBLEM:
Corporate personage = limited liability = limited accountability
from the Munger excerpt: “insufficient controls over morality and prudence in banks and investment banks”
Banks as corporate entities do not and cannot have morality or prudence; only real persons are capable of either and if those persons who control corporations have little or no morality or prudence…, we get what we have today.
“How Corporations Became ‘Persons’ http://www.uuworld.org/2003/03/feature1a.html
The amazing true story of a legal fiction that undermines American democracy.
“”Corporations have been enthroned and an era of corruption in high places will follow, and the money power of the country will endeavor to prolong its reign by working upon the prejudices of the people until all wealth is aggregated in a few hands and the Republic is destroyed.” – A. Lincoln
If only we could return to the earlier day as written in the above article:
In the early days of the republic, most corporations were what we now call nonprofit organizations; the for-profit corporations were largely banks. Then as now, charters were issued by states, each under its own laws. But early charters specified the corporation’s purpose and expired at the end of a set term. If corporations overstepped their boundaries their charters could be—and not infrequently were—revoked. Corporations could not own shares in other corporations, so mergers and acquisitions and subsidiaries were unknown. They certainly could not curry political favor with campaign donations. This sweeping prohibition on political activity is from a Wisconsin statute that was in force well into the twentieth century:
No corporation doing business in this state shall pay or contribute, or offer consent or agree to pay or contribute, directly or indirectly, any money, property, free service of its officers or employees or thing of value to any political party, organization, committee or individual for any political purpose whatsoever, or for the purpose of influencing legislation of any kind, or to promote or defeat the candidacy of any person for nomination, appointment or election to any political office.
Corporations that violated this law faced charter revocation and “any officer, employee, agent or attorney or other representative of any corporation, acting for and in behalf of such corporation” would be subject to a fine and “imprisonment in the state prison for a period of not less than one nor more than five years.”
All the above and more in the way of constraints on corporations was eroded away over the decades by Supreme Court decisions that ended up establishing the corporate “person” which has virtually the same standing in law a real person except the corporation per se cannot do hard time in a Federal pen.
February 12th, 2009 at 1:04 pm
More from the article, especially grating see the bottom paragraph which includes this
“The court argument that corporations used to gain personhood was that corporations constituted persons under the Fourteenth Amendment—the 1868 measure whose aim was to ensure full personhood to the freed slaves.”
“How Corporations Became ‘Persons’ ” http://www.uuworld.org/2003/03/feature1a.html
Corporations gained personhood through aggressive court maneuvers culminating in an 1886 Supreme Court case called Santa Clara County v. Southern Pacific. Until then, only We the People were protected by the Bill of Rights, and the governments the people elected could regulate corporations as they wished. But with personhood, corporations steadily gained ways to weaken government restraints on their behavior—and on their growth. After steady progress over the decades, they made huge strides in the 1970s through Supreme Court rulings that awarded them Fourth Amendment safeguards against warrantless regulatory searches, Fifth Amendment double jeopardy protection, and the Sixth Amendment right to trial by jury. These blunted the impact of the Clean Air Act, the Occupational Safety and Health Administration Act, and the Consumer Product Safety Act, which were enacted to protect workers, consumers, and the environment.
They also won court battles that awarded them First Amendment guarantees of political speech, commercial speech, and the negative free speech right not to be associated with the speech of others. On the surface, when the big corporations and We the People have the same rights, they are equal, and the playing field is level. But disparities of scale tip the field toward the corporations at a steep pitch. If a nation-sized corporation with its huge treasury and squadrons of lawyers wants to exercise its free speech rights in a shouting match with a citizen who is exercising her or his free speech rights, can this be a fair fight?
The Supreme Court has ruled that corporate political speech includes the right to spend millions on lobbying in Washington and to contribute more millions to political campaigns, and corporations have no greater tools for making government their ally. As for commercial speech—advertising, largely—research by Wayne McIntosh and Cynthia Cates of the University of Maryland shows that commercial speech cases, once nonexistent, have become the Supreme Court’s “single most emphasized issue, composing nearly one-quarter of the speech docket over the last decade.”
“The end result,” says Ward Morehouse, cofounder with Richard Grossman of the pioneering group of prodemocracy thinkers known as POCLAD, short for the Program on Corporations, Law, and Democracy, “is that they exercise greater rights than actual persons, and this is an absurd situation.” Morehouse (see profile, page 38) says that in addition to the rights granted them by the Supreme Court, under the law corporations have limited liability, can live on indefinitely, and, while their employees may be tried in criminal courts, corporations themselves cannot.
Another way personhood amplifies corporate power is cruelly ironic in a way that underlines the amoral nature of the marketplace. The court argument that corporations used to gain personhood was that corporations constituted persons under the Fourteenth Amendment—the 1868 measure whose aim was to ensure full personhood to the freed slaves. If this sounds preposterous to you, you’re hardly alone; researchers have been scouring archives in an effort to make sense of it but so far have no conclusive explanation.