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Sunday, May 10, 2009

From Charlie Munger - Latest Wisdom at WSC 2009 Shareholder Meeting

After attending the Berkshire Hathaway shareholder (BRKA)meeting last few years, this year I attended WESCO Financial Corporation (WSC) 50th shareholder meeting instead. WSC is run by Charlie Munger who is also vice-chairman of BRKA. After reading a book on Charlie Munger last year, I am fascinated by the man. He has been one of my heroes for a few years and my admiration for him continues to increase as I learn more from him.

WSC shareholder meeting is a very different affair than BRKA shareholder meeting. WSC meeting is brief and to the point, just like Munger:-)

Following are my notes from the meeting (note the direct communication style of Munger):

Munger started the meeting with answering the questions he had prepared for himself:-)

Q1: How serious is the economic mess?

A: It is deadly serious. People are extremely disappointed and you can't tell what happens when people are extremely disappointed.

Q2: What caused the economic mess?

A: Economics is a Complex System and it is always a confluence of causes that destabilize a complex system. The major causes are:

1. Abusive Practices in Consumer Credit: Money was available to anyone and everyone. When consumers can get easy credit they consume things they don't need. In addition, a multiple credit card borrower is a terrible borrower. He can keep on getting a new credit card to make payments on previous cards until the house of cards collapses.

2. Mortgage Credit: Loans were given to people who could not afford them. Some lending practices are deceptive and some consumers were irresponsible i.e. they took loans they could not afford. It was not sustainable.

3. Wall Street went Crazy: Executives developed a mentality that anything goes short of bribery. The last acquisition Merill Lynch made [I think it was First Franklin] before the economic crisis was a company of crooks. The thought was that as long as they are making money, who cares that they are crooks.

4. Legislators and Regulators: Both were foolish. Some thought that socialized housing was good for the economy. Credit practices should be like engineering practices because they form foundation of the finance industry.

5. Envy: Both consumers and lenders thought that everyone was doing it [borrowing and lending] and getting rich so they should do it as well.

6. Repo System of Credit: This was double dose of insanity.

Both Republicans and Democrats were not doing their jobs. Republicans had an overdose of Ayn Rand and Democrats were in love with the idea of housing for the poor.

The sales people were getting 9% commission for selling credit. This is equivalent of making armed robbery legal for anyone below 25. The results should have been obvious. People should be wary of anyone who gets high-commission by selling you something.

7. Leverage: Credit Default Swaps (CDS), Derivatives, etc. made the financial institutions and the financial system too leveraged and very risky.

Insurance companies had developed good rules re leverage and credit people threw them out. CDS market was in trillions of $. Accounting was phony re derivatives as both parties involved in the transaction reported profits with every transaction.

People thought that the predatory practices were OK. [Alan] Greenspan made it seem respectable.

Q3: How has been the Government's response to the economic crises?

A: There has been some injustice in government's response. However, injustice is part of the world. Overall, the government response to the crises has been good. The quick nationalization of Freddie and Fannie was a good step and so was fast lowering of interest rates.

Re banks, the response has not been so good. However, the results remain to be seen. In the meantime, Wells Fargo [BRKA owns part of Wells Fargo] is gaining market share Andrew Carnegie style.

Q4: How is the government doing re the environment?

A: Using ethanol as fuel is monstrously stupid idea. In the analysis that is shown to pubic, the total cost of producing ethanol is not included. In addition, use of ethanol as fuel increases the cost of food and cheap food is important for US economy.

Cap and Trade is a really stupid idea. We don't need anything like that and it is not going to work in the interconnected global marketplace we live in.

We know that the hydrocarbons are a limited resource. We should preserve hydrocarbons for later use and slow down on their use. The only way to solve the energy problem is to harness the energy of the Sun. We already know how to create the electric grid. Even if the cost is a bit higher, smart grid is an excellent idea.

Chinese may take a lead on harnessing solar energy since they are suffering the most from brown coal.

There are many ways to harness the power of Sun. Photovoltaic may be the best option. The cost of solar cells will decline more than 50% from where it is today.

Half the water in Israel is coming from the sea. The world is moving in the same direction to get water from the sea.

For people to install little systems in their garages to generate energy from solar cells is not a good idea. Let the utilities do their job of designing and maintaining large engineering systems because solar power requires time-shifting. The Sun does not shine at night and the demand fluctuates.

Lithium Ion batteries are a good way to store electric power. They may allow Arabs and Israelis to live together [shared resources for water and electricity].

Modern civilizations like ours can handle change if it comes over a long period of time i.e. if global warming will make sea level rise a little bit over next hundred years, we can handle it.

Chinese form of government is good. When they need to do something, they do it. And, it is run by engineers. On the other hand, Indian form of government is not good. They have too much due process since Indians copied their government policies from the British.

Singapore government, also run by engineers, is the best government focused on results and meritocracy. US should be run more like Singapore.

When Japan got in economic trouble, it could handle 0% GDP growth for ten years. US can not handle it. In Japan, stimulus money from the government was used to fill the same pot hole three times. It was a waste. The US government should use the stimulus money towards solar energy.

In Iowa, 20% of electricity comes from the wind.

Q5: What about stocks?

A: This is a very good time to buy stocks. If you wait to buy [stocks] until economy is back to normal then it is too late.

Coca Cola and Wells Fargo are very good investments today.

Q6: What new regulations should the government implement?

A: A major investment bank which is too big to fail should be a very boring business. This is how it used to be and everything worked fine. Government should take away all activities which are not boring from the investment banks. They should focus on activities like market making and capital raising.

Massive leverage is bad for the system. No CDS should be allowed. Pretty gaming (2x leverage) should be allowed for hedge funds. However, ballooning of the hedge fund operations should not be allowed. In addition, pay should not be high for hedge fund managers.

Obama should run the country like Lee Kuan Yew [Singapore]. He is trying to reduce the power of wall street which is a very good idea. However, likelihood of Obama having success with it is not high.

It is not pretty to take money away from people because you play better cards and you let them play. Deception and gambling should be driven out of the system.

Excerpts from Audience Q&A:

At current prices, BRKA is a better buy than WSC.

In a world where Toyota has a problem, Detroit has hell of a problem.

It is not unthinkable that over time a geographical area loses its luster. Detroit does not have to remain "Detroit".

Everyone should maximize social security net.

Not many people get felicity by aiming low.

Outliers by Malcolm Gladwell is an excellent book.

A world with no inflation is not coming up.

Don't expect perfection.

Re leadership, some people are more teachable than others. Following three qualities are essential in any leader:
  1. Trust: She should be trustworthy
  2. Ability: She should have the ability to do the job
  3. Judgement: She should have good judgement

Human misjudgement will always be part of the world.

We have found new natural gas resources which should help with the energy problem.

The world will adapt to the new oil prices.

Japan is not a disaster with 0% GDP growth. It is in nature of things that the monolithic population gets along better than a diverse population like the US population.

There are limits to growth.

It takes $100M/year in marketing spend to maintain a brand in the US. GEICO is spending $800M in advertising this year- $100M to maintain the brand and $700M to gain new business.

In most cases, reverse mortgage is not a good idea.

Rich people should volunteer their time for politics and public serving organizations just like Benjamin Franklin did. The trustees of University of Michigan and University of Notre Dame volunteer their time to be on the boards of these Universities. Same model should be followed by corporations as they are public bodies. Directors of corporations should not be paid. Solving interesting problems at the corporations should be a big enough reward for rich people who volunteer their time to be on the board.

Needs should not be sacred. You should always be able to cut back. And, you should not take on debt to maintain your lifestyle.

Corporations should be held responsible for their actions. Walmart may have more influence on the US society than Harvard does.

A lot of discipline is required to live a good life.

Real estate market recovery will be geography specific in the US i.e. the entire country will not recover at the same time.

China was a world leader 600 years ago. The protectionist policies made them fall behind. However, once again, China has a bright future since it is run by engineers.

Confucianism is good because it focuses on:
  • Family
  • Learning
  • Respect for old people
  • Work ethic
The Confucianism principles have helped Wang Chuan-Fu [present at the meeting] start BYD, which is the largest Chinese manufacturer, with a $3,000 loan from his cousin.

Culture and Genetics work together in evolution.

It is easy to fall backwards especially under affluence.

As time passes, some rise and some fall. It is in nature of things. People who try harder can keep the baton with them longer. Athens, Egypt, and London used to be the biggest powers in the world. They have a very different place in the world now. Nothing lasts forever.

The profession of Finance has witchcraft in it. The Finance professors try to make it look like physics with complicated equations. The equations belong in physics and not in Finance. The professors teach diversification which by definition is average.

In running a business, trusting your people is critical. And, trust comes when people in the organization have:
  • Understanding of the business
  • Understanding of human nature
  • Understanding of numbers
Smart people are the ones who avoid dumb mistakes and make rational decisions.

Companies should fire customers who are not helping them make money.

Companies should take care of their suppliers.

Microeconomics of newspaper business are tough to overcome. The future for newspaper business is not bright.

Sometimes good does not win.

Deliver the service you want.