Thursday, May 14, 2009

An Interview with Charlie Munger

by Bill McBride on 5/14/2009 03:53:00 PM

Stanford Law Professor Joseph Grundfest interviews Charlie Munger, vice chairman of Berkshire Hathaway: Legal Matters

Munger makes a number of interesting comments (I believe many of you will find the interview interesting). Here are a few excerpts ...

On accounting:

Grundfest: As we look at the current situation, how much of the responsibility would you lay at the feet of the accounting profession?

Munger: 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.

Grundfest: Would you give an example of a particular accounting practice you find problematic?

Munger: 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.

Grundfest: And they can’t both be right. But both of them are following the rules.

Munger: Yes, and nobody is even bothered by the folly. It violates the most elemental principles of common sense.
And on derivatives:
Grundfest: You and your partner, Warren Buffett, have for years warned about the dangers of the modern derivatives markets, particularly credit derivatives, and about interest rate swaps, currency swaps, and equity swaps.

Munger: Interest rate swaps have enormous dangers given their size and the accounting that has been allowed. But credit default derivatives took that danger to new levels of excess—from something that was already gross and wrong. In the ’20s we had the “bucket shop.” The term bucket shop was a term of derision, because it described a gambling parlor. The bucket shop didn’t buy any securities. It just enabled people to make bets against the house and the house furnished little statements of how the bets came out. It was like the off-track betting system.

Grundfest: Until the house lost its money and suddenly disappeared. Or the house made its money and suddenly disappeared.

Munger: That is right. Derivatives trading, with no central clearing, brought back the bucket shop, because you could make bets without having any interest in the basic security, and people did make such bets in the billions and billions of dollars. Some of the most admired people in finance — including Alan Greenspan — argued that derivatives trading, substituting for the old bucket shop, was a great contribution to modern economic civilization. There’s another word for this: bonkers. It is not a credit to academic economics that Greenspan’s view was so common.
There is much more.