[pdmunro]

Charles Munger (Warren Buffett's Vice Chairman at Berkshire Hathaway) argues the case for financial reform (March 3, 2010, Bloomberg).
Source: http://www.bloomberg.com/avp/avp.htm?N=vid...17qyNcGVG0s.asf
Transcript from before half-way point (7:50/19:13) of interview.

"Interviewer: You said in the press conference earlier that the investment banking system needs to be foolproof.

Charles Munger: Yes. We approve of that.

I: How do you do that though?

CM: Well we do it the way we did it last time. We just take away a lot of the activities that are permitted to the business. If you are going to directly, or indirectly, use the government's credit, you shouldn't have the right to use any amount of credit you please to do any gambling you want with the assets. And that is in effect the system that we've had.

At Lehman they just did anything they want(ed) with any amount of leverage and they just assumed that the repo (overnight loans) system, or some other system would enable them to balloon the balance sheet to any size. And of course the derivatives had made things so confusing that people could hardly notice the ridiculous changes that were occurring in terms of the risks being undertaken. So the system was all wrong.

You can see this in terms what happened to Salomon. When we (Berkshire Hathaway executives Warreen Buffett and Charles Munger) were at Salomon. Perfectly decent place with much more good than bad about it. And decent smart leaders too, by in large. And they had a proprietary trading group and they got more and more successful and made more and more money. And finally the whole retained earnings of Salomon came from proprietary trading.

Anything else they made, the executives took out as compensation. Or the other employees. And because they were making so much money, no one wanted to tell them they couldn't expand. And so they kept using more and more leverage, and more and more discretion, and so forth. Now that same group left Salomon, the (John) Meriwether group. But we know now what would have happened if they had stayed: Salomon would have gone broke at the same time Long Term Capital Management went broke because they would have had the same trades on, and they would have had the same high leverage. And Salomon would have gone broke.

Those people had very high IQ's and were honest people and they still would have caused Salomon to go broke and Salomon would have allowed it to happen because no one would have wanted to rein in the proprietary trading. Those dynamics are present all through Wall Street. And, of course, one after another they will go "blue ear" (broke) if they keep having these perogatives to use the government's credit while they do any damn thing they want with massive leverages, which is exactly what they want to do.

The envy effects are so (pervasive). If Jo Schmo gets $4 billion dollars to gamble with in Italian hotels, then Pete Silly, over here, he wants $5 billion to do something else with. It just balloons and balloons and balloons. And the theory (that) it could all be managed with a bunch of risk control officers who believe the value at risk. Well Warren and I always knew that their system was perfectly silly and wouldn't really control risk. And, of course, that's exactly what happened. It didn't really control risk, and it was a silly system.

The very fundamentals of their system in terms of theory were wrong. They thought that outcomes in finance had to fall on a Gaussian (bell-shaped) curve. That's a wrong assumption. So you had total craziness in the system. And with virtually nobody at the SEC understanding what was going on. And most of the people in the investment banks didn't understand what was going on. And you have massive envy triggered as these people make these vast fortunes quickly.

And that is not a responsible system for people to in effect use the government's credit to do any damn thing they please and so the whole thing should be reined in. We should just take (it) away.

If you want to use the government's credit, including its implicit credit when you're "too big to fail", then you have to be willing to run a pretty boring business that a pretty stupid person if he followed the rules wouldn't go broke."

Other interviews with Charles Munger: http://www.valuestoc.../charlie-munger

[Winstonm]

Impressive and well-stated.