Monday, June 15, 2009

John Bogle and Charlie Munger on Frictional Costs

Some excerpts from John Bogle's book: The Battle for the Soul of Capitalism.

"By the latter years of the twentieth century, our business values had eroded to a remarkable extent. Yes, we are a nation of prodigious energy, marvelous entrepreneurship, brilliant technology, creativity beyond imagination, and, at least in some corners of the business world, the idealism to make our nation and our world a better place. But I also see far too much greed, egoism, materialism, and waste to please my critical eye." - John Bogle

"While our nation's largest arena, the stadium at the University of Michigan, holds but 107,501 citizens—one-third the 320,000 capacity of the Circus Maximus—television screens bring U.S. sports and entertainment to worldwide audiences that reach into the billions. As stocks became entertainment, perhaps our greatest circus became our financial markets." - John Bogle


"When we should be teaching young students about long-term investing and the magic of compound interest, the stock-picking contests offered by our schools are in fact teaching them about short-term speculation. And the biggest financial circus of all—today's incarnation of the Circus Maximus—is the garish eight-story NASDAQ MarketSite Tower in Times Square, displaying stock prices on what is proudly billed as the 'world’s largest video screen.' That display, it seems to me, is the visual paradigm of a stock market that has become not only a circus, but a casino for speculators. Yet as Lord Keynes warned us: 'When the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill-done.'" - John Bogle


Successfully changing prevailing investing habits from A) today's high frictional cost with an emphasis on speculation, to B) low frictional cost with emphasis on compounding value long-term is, at least based upon recent history, difficult at best. Many market participants -- though, of course, certainly not all -- have developed their skills in, and been influenced by, a system that encourages increasingly short-term oriented behavior. Business incentives and entrenched interests remain that seem likely to keep current norms at least mostly in place. So changing the status quo to any great degree won't be easy. Still, even if it is only by small degrees over the next 20-30 years, it's worth attempting to tilt things in the direction of B). The current way of doing business is a "hidden tax" both in terms of unnecessary frictional costs, and the increased allocation of capable engineers, mathematicians, and scientists toward largely unproductive activities.

Charlie Munger builds upon the term 'bezzle', which was coined by Professor John Kenneth Galbraith to help explain why misappropriated funds can actually be -- even if only in the near-term and, to say the very least, in far less than optimal ways -- economically stimulative:

"Are there important functional equivalents of 'bezzle' that are large and not promptly self-destructive? My answer to this question is yes. I will next describe only one. I will join Galbraith in coining new words, first, 'febezzle', to stand for the functional equivalent of 'bezzle' and, second, 'febezzlement', to describe the process of creating 'febezzle', and third 'febezzlers' to describe persons engaged in 'febezzlement'. Then I will identify an important source of 'febezzle' right in this room. You people, I think, have created a lot of 'febezzle' through your foolish investment management practices in dealing with your large holdings of common stock.

If a foundation, or other investor, wastes 3% of assets per year in unnecessary, nonproductive investment costs in managing a strongly rising stock portfolio, it still feels richer, despite the waste, while the people getting the wasted 3%, 'febezzlers' though they are, think they are virtuously earning income. The situation is functioning like undisclosed embezzlement without being self-limited. Indeed, the process can expand for a long while by feeding on itself. And all the while what looks like spending from earned income of the receivers of the wasted 3% is, in substance, spending from a disguised 'wealth effect' from rising stock prices." - Charlie Munger speaking to investors at the Philanthropy Round Table in 2000.


Munger also added the following back in 2005:

"It's my guess that something like 5% of GDP goes to money management and its attendant friction. ...Worst of all, the people doing this are among the best and the brightest. Hundreds and thousands of engineers, etc. are going into hedge funds and investment banking. That is not an intelligent allocation of the brainpower of the civilization." - Charlie Munger at the 2005 Wesco meeting

As always Munger calls it as he sees it no matter who is in the audience.

The system can still work just fine for those who stick to what they know, focus on the long-term, and avoid the folly

Adam

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