Wednesday, May 4, 2011

Munger on the Financial Sector: "Whole System is Stark-Raving Mad"

On Monday, Charlie Munger spoke to Bloomberg Businessweek on his views of Wall Street's role in Europe's financial crisis. He describes how investment bankers helped mask Greece's troubles as "perfectly disgusting." From the article:

"Why should an investment banker go to Greece to teach them how to pretend their finances are different from what they really are? Why isn't that a perfectly disgusting bit of human behavior?"

In a separate interview with CNNMoney, Munger said that the financial sector should be downsized by about 80%. He doesn't see much benefit to the massive amount of trading between computers that goes on. He also doesn't seem to think the energy expended and talent utilized writing algorithms (that ultimately the rest of us pay for) provides much social contribution.

"...why should we want to encourage our brightest minds to do what amounts to code-breaking and electronic trading? No I think the whole system is stark-raving mad. Why should we want 25% of our graduating engineers going into finance?"

Charlie Munger: Get Rid of 80% of the Financial Sector

Munger also added the following:

"...short term trading is legalized front-running. It's just done electronically with code-breaking skills. I don't see any social contribution."

Basically, banking should more closely resemble the utility function that it has played in the past.

The Public-Utility Function

The Banking Power Utility

Michael Lewitt, president of Harch Capital Management, said in this Barron's article that the balance needs to be shifted back to favoring the public-utility function of the financial system.

What makes Munger's comments somewhat more interesting is the substantial investments in financial stocks that Berkshire Hathaway (BRKa) has at this point (Wells Fargo: WFC, U.S. Bancorp: USB, and Goldman Sachs warrants). So what Munger is saying cannot be described as beneficial to Berkshire Hathaway.

Charlie Munger later said this in the CNNMoney interview:

"...we invest in the world as it is. But if you ask me what the world should be, I would say that the finance sector of the world should be downsized by at least 80%."

...and when asked if it were downsized would they still invest in the banks they favor (Wells Fargo, U.S. Bancorp):

"Of course, it wouldn't affect us at all."

That 80% downsizing may seem like a stretch but consider that finance now makes up 8-9% of GDP. Up until the 1980s finance rarely occupied more than 4% of GDP and has fluctuated frequently around more like 3%. So some may say 80% is too much but let's just say an awful lot of downsizing would seem to make sense.

"What is Wall Street supposed to do? It's not a creator of wealth. It's a handmaiden to creators of wealth. It occupies an essentially parasitic, but usefully parasitic relationship with the rest of the society. It's totally out of control. It's not making America a great place; it's making America a worse place right now. That's the problem. Finance needs to occupy a healthier, more productive relationship with the rest of the society." - Michael Lewis, author of The Big Short, in this 2010 Bloomber Interview

I happen to think Wells Fargo and U.S. Bancorp, though not perfect by any means, come closer to the idea of performing the good old-fashioned utility function of banking. They're two of the better houses, with very good economics relative to peers, residing in a neighborhood with lots of excess.

Goldman Sachs, who may play the modern finance game as good as or better than their investment banking peers, still seem the ultimate symbol and example of the less than non-productive excesses that occurred and continue to this day.

Adam

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