Munger falls prey to the psychology of human misjudgement
In 1995 at the Harvard Law School, Warren Buffett's business partner, Charlie Munger, gave a speech titled 'The Psychology of Human Misjudgement'. The speech lists 24 standard causes of mental error. During this year's Wesco meeting, Munger fell prey to at least one of them.
Exhibiting a refreshing eagerness to criticise almost anyone remotely involved in the financial crisis, from academics to accountants and investment banks to regulators, Munger neatly explained the basic mechanics of the system. Active people get rich, he says, and then they buy the favour of politicians. Auditors, accountants and ratings agencies, even regulators, go along for the ride.
In 1995 at the Harvard Law School, Warren Buffett's business partner, Charlie Munger, gave a speech titled 'The Psychology of Human Misjudgement'. The speech lists 24 standard causes of mental error. During this year's Wesco meeting, Munger fell prey to at least one of them.
Exhibiting a refreshing eagerness to criticise almost anyone remotely involved in the financial crisis, from academics to accountants and investment banks to regulators, Munger neatly explained the basic mechanics of the system. Active people get rich, he says, and then they buy the favour of politicians. Auditors, accountants and ratings agencies, even regulators, go along for the ride.
It was hard to believe that many in the auditorium weren't thinking of Goldman Sachs at this point. Goldman's political action committee was one of the biggest donors to Obama's election campaign. There are so many ex-Goldman employees now working in Washington, from the Treasury to the Federal Reserve, that the investment bank is sometimes called 'Government Sachs'. And it employs more than 30 former government officials as lobbyists. It's impossible to imagine Munger being ignorant of these facts.
Munger holds strong views about how business should be conducted. He wants to sell people things that are good for them, believing that businesses should serve individuals and society at large. You can't imagine him running casinos or selling cigarettes, for example.
Here again, investment banks were on the audience's mind. The latest revelations from the New York Times show that Munger's statement that 'Wall Street needs an adult in the room' was quite correct. Goldman Sachs was making markets, betting against many of its clients and serving no useful social purpose.
Munger clearly understood this, making a strong case for the separation of commercial banks from investment banks and for banks being prevented from running commodity markets and gambling on derivatives. He said that, 'we need to limit what Goldman can do' and that, 'Most banks still think it's someone else's fault'.
It was a searing critique of an amoral, dangerous system, the solution to which, Munger implied, wasn't that different from the regulations we had before the banks lobbied to have the rules changed in their favour.
And then, in the questions afterwards, the moment came, just as it had at the Berkshire Hathaway meeting the previous week.
In response to a question on Berkshire's holding in the company at which so many of Munger's barbs were surely directed, Munger expressed satisfaction with the investment in Goldman Sachs. It was 'probably the most ethical of the investment banks that had just lost its way', he said.
That's a remarkably weak explanation for a company that played a leading role in the greatest financial crisis since the Great Depression.
How this holding is consistent with Munger's own beliefs is difficult to fathom. Do Buffett and Munger seriously believe that over the past decade or so investment banks have been a net benefit to society? Surely not. So why buy Goldman stock?
The explanation can be found in biases 2 and 15 of Munger's essay. Bias two he terms 'simple psychological denial'. Holding stock in a business that has so clearly been calamitous for ordinary people can't be easy. Either one owns up to it and sells out or holds on and pretends the company has 'just lost its way'. Munger seems to have chosen the latter.
He has made it clear that Goldman was Buffett's investment, not his, and that, surely, is explained by bias seven; 'bias from over-influence by social proof – that is, the conclusions of others'.
Which of us hasn't at least once sacrificed our principles or acted against our beliefs out of loyalty to a friend? And how many of us have gone along with a decision, despite gnawing concerns, because another person appears better placed to make it?
It would be easy to criticise Munger for what appears to be an irreconcilable position; to decry the practice of investment banking over the past decade or so and then buy stock in a company that played a leading role first in creating the crisis and then profiting from it.
But that would be to miss the point; Munger is, after all, human. Whilst he may be skilled in avoiding the errors of judgement to which we are all prone, he is not untroubled by them.