On what the Madoff affair teaches us about the financial system:
... there are mixed schemes that are partly Ponzi just shot through American business. The conglomerate rage of buying companies at 10 times earnings and issuing stock time after time at 30 times earnings to pay for them was a legitimate business operation mixed with a Ponzi scheme. That made it respectable. Nobody called it illegal. But it wasn't all that different from mixing a significant amount of salmonella into the peanut butter.Why our regulators aren't capable of addressing so many of the regulatory issues in the market today:
Most of them plan to go back to living off money made in the system they are supposed to regulate. You can argue that financial regulation is so important that no one in such a position should ever be allowed to [...] serve and then leave to make money in the regulated field. Such considerations led to lifetime appointments for federal judges. And we got better judges with that system.What mistakes Munger sees other executives making:
An extreme optimism based on an inflated self-appraisal is one. I think that many CEOs get carried away into folly. They haven't studied the past models of disaster enough and they're not risk-averse enough. One of the very interesting things about Berkshire Hathaway is how chicken it is, how cautious, how low is its leverage. But Warren and I would not have been comfortable with more risk, entrusted with other people's net worths. There was no reason for our financial institutions to stretch as much as they did, with the leverage, the shady people and the compromises.For more on just about anything related to the financial crisis and recession, check out the whole interview.
Worth noting is the extent to which Munger puts the current situation at the feet of the accounting profession:
I would argue that a majority of the horrors we face would not have happened if the accounting profession developed and enforced better accounting. They are way too liberal in providing the kind of accounting the financial promoters want. They've sold out, and they do not even realize that they've sold out.
Take derivative trading with mark-to-market accounting, which degenerates into mark-to-model. Two firms make a big derivative trade and the accountants on both sides show a large profit from the same trade.
It violates the most elemental principles of common sense. And the reasons they do it are: (1) there's a demand for it from the financial promoters, (2) fixing the system is hard work, and (3) they are afraid that a sensible fix might create new responsibilities that cause new litigation risks for accountants.
Munger's broader emphasis on the gradual de-professionalization of business since he was young (when, e.g., the investment bank "First Boston Company was an honorable and constructive firm and very much served the surrounding civilization"), and his proportionate condemnation of regulators and business leaders, recalls a recent Fortune column by David Gergen. Rallying for the institution of higher professional standards in corporate management, Gergen cites an argument in the October 2008 Harvard Business Review by Rakesh Khurana and Nitin Nohria -- a variation on one first made back in the '20s and '30s -- that management should become a "true profession" like law or medicine, with a code of conduct, an explicit commitment to social responsibility, and professional enforcement boards.
The importance of such professionalization, Gergen stresses, is as much to save capitalism from being saved by regulation as it is to save anyone from capitalism: "Unless corporate leaders can soon persuade the public to put down their pitchforks, they can expect government to become more and more a master."
" I would argue that a majority of the horrors we face would not have happened if the accounting profession developed and enforced better accounting."
We take horribly inadequate accounting for granted. It is not just accountants who let one another off the hook for gross professional inadequacy. The rest of us expect nothing better from them.
Governments are so ingrained in sheltering their policy inadequacies behind obviously incomplete accounts that they are thoroughly inhibited from doing anything effective to improve accountancy in general. Indeed, before the current crisis I used to think that private sector accounting was substantially better than most government accounting - which merely shows how little I had thought about business accounting.
Maybe our chastened bankers can begin to apply the pressure needed to truly professionalise accounting.
I'm going to take an extraordinary leap of faith and say that . . . (deep breath) . . . thisvicechairmanofasupersuccessfulcompany is right.
Phew! Glad I got that off my chest.
The idea of professional standards among the financial class is a great one - but I wonder how effective life-time appointments for regulators would be. As long as the compensation in the financial sector is so unfairly lavish, there's always going to be a draw for the best people into those positions. And I don't see the Treasury or the SEC offering seven figure contracts for regulators.
But it's a welcome point that, with poor accounting and terrible oversight, these people were architects of their own demise. Wall Street has shown an amazing capacity to ignore past failures, and a truly commendable blindness to future risk.
Someone (Krugman? I hate quoting Krugman. Everyone quotes Krugman) pointed out that the Ponzi scheme metaphor is incredibly apt - these people took huge risks with leveraged capital, and the supposed profits that we all bought into, our supposedly vast 401ks - were artifacts, illusionary. They were false returns based on false expectations, and for the most part, they aren't coming back.