The latest issue of Stanford Lawyer runs a fantastic interview with Charlie Munger, the no-nonsense, super-smart vice chairman of Berkshire Hathaway -- and one of the few to have seen the current financial train wreck coming miles away.
On what the Madoff affair shows us about the financial system:
... there are mixed schemes that are partly Ponzi just shot through American business. The conglomerate rage of buying companies at 10 times earnings and issuing stock time after time at 30 times earnings to pay for them was a legitimate business operation mixed with a Ponzi scheme. That made it respectable. Nobody called it illegal. But it wasn't all that different from mixing a significant amount of salmonella into the peanut butter.
Why our regulators aren't capable of addressing so many of the key regulatory issues in the market today:
Most of them plan to go back to living off money made in the system they are supposed to regulate. You can argue that financial regulation is so important that no one in such a position should ever be allowed to [...] serve and then leave to make money in the regulated field. Such considerations led to lifetime appointments for federal judges. And we got better judges with that system.
What mistakes Munger sees other executives making:
An extreme optimism based on an inflated self-appraisal is one. I think that many CEOs get carried away into folly. They haven't studied the past models of disaster enough and they're not risk-averse enough. One of the very interesting things about Berkshire Hathaway is how chicken it is, how cautious, how low is its leverage. But Warren and I would not have been comfortable with more risk, entrusted with other people's net worths. There was no reason for our financial institutions to stretch as much as they did, with the leverage, the shady people and the compromises.
But what's especially notable is how Munger puts the current situation squarely at the feet of accountants:
I would argue that a majority of the horrors we face would not have happened if the accounting profession developed and enforced better accounting. They are way too liberal in providing the kind of accounting the financial promoters want. They've sold out, and they do not even realize that they've sold out.
Take derivative trading with mark-to-market accounting, which degenerates into mark-to-model. Two firms make a big derivative trade and the accountants on both sides show a large profit from the same trade.
It violates the most elemental principles of common sense. And the reasons they do it are: (1) there's a demand for it from the financial promoters, (2) fixing the system is hard work, and (3) they are afraid that a sensible fix might create new responsibilities that cause new litigation risks for accountants.
Munger's broader emphasis on the gradual de-professionalization of business since he was young (that is, when the investment bank "First Boston Company was an honorable and constructive firm and very much served the surrounding civilization"), and his proportionate condemnation of regulators and business leaders, echoes a recent David Gergen column at Fortune. Rallying for higher professional standards in corporate management, Gergen cites an argument in the October 2008 Harvard Business Review by Rakesh Khurana and Nitin Nohria -- a variation on one first made back in the '20s and '30s -- that management should become a "true profession" like law or medicine, with a code of conduct, an explicit commitment to social responsibility, and professional enforcement boards.
The importance of such professionalization, Gergen stresses, is as much to save capitalism from being saved by regulation as it is to save anyone from capitalism: "Unless corporate leaders can soon persuade the public to put down their pitchforks, they can expect government to become more and more a master."
This article available online at: