Interview · 2009

The Current Economic Crisis — Munger with Joseph Grundfest (Stanford, 2009)

2009 25m video

Source: Stanford · embedded from the original; we don’t host it.

Grundfest — an ex-SEC commissioner — is the right interlocutor to get Munger going on the crisis. Twenty-five minutes on what efficient-market theory missed, why derivatives were bucket-shop gambling with a respectable name, and how the accountants and regulators failed.

financial crisis economics regulation accounting

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Stanford University Charlie you've often complained that accountants are the root of much evil and also of even more Folly um you know as we look at the current situation that we have in our financial markets how much of the responsibility would you lay at the feet of the accountant profession well here I'm a voice in the wilderness but I would argue that a majority of the horrors we faced would not have happened if the accounting profession were organized properly in other words they have a position from which if they behaved intelligently and correctly they could prevent a huge amount of all that's wrong with the system and they fail utterly Time After Time After Time and they are way too liberal and providing the kind of accounting the financial promoters want so in other words they've sold out and they do not even realize that they've sold out which of course is a common human psychological phenomenon you squelch by denial so what examp what if you recognize would make you think ill of yourself or would interfere with your income and so at a subconscious level without any malevolence the accounting profession are behaving in a way that makes well compared to what could reasonably be with intelligence and honor uh the accounting profession is a sewer and would you give an example could you give an example of a particular accounting principle or practice that you think promotes trading with Marto 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 right from the same trade and they can't both be right and they can't both be right and both of them are following the rules to the te yes and nobody's even bothered by the fact that it's happening right it violates the most Elemental principles of Common Sense and the reason they do it is there's a demand for it from the financial promoters I remember when interest rate swap accounting was done on a different and more conservative basis and the Morgan Bank was the last hold out and finally they couldn't hold their Traders and Report the same kind of income other people reported and so they threw out the sound accounting and went to the phony accounting uh and they did it was kind of funny at the time was many decades ago and some of the people were kind of reluctant but they said we just have to go with the flow it was a huge mistake is this a problem that can be fixed with the accounting profession with the accounting process or is this something that we're just going to have I think you're talking about a problem rooted so deeply in human nature that uh I don't think you'll live long enough to see it if it gets 20% fixed in the direction it should go in your remaining lifetime you'll be a fortunate man so how do we get there so let's assume that we actually want to accomplish something good in this know how to transform all human life into we're just talking about the accting Charlie well but accounting is a big subject and there are huge forces in play and the entire momentum of existing thinking and existing C custom is in a direction which allows these terrible folies to happen and the terrible folies have terrible consequences what we're in now is in it's triggering circumstances it's worse than anything that's ever happened worse than the Great Depression yes not no we're not the economy hasn't contracted as much as the Great Depression M but the Mal and silliness was the triggering event was way greater so other words more widespread in the 20s a tiny little class of people were our financial promoters and a tiny little class of people were the people that bought Securities this now is deep in the whole culture and it was way more extreme so if sin and Folly get punished we're in for a hell of a punishment so it's it's a more pervasive problem and it's also a more Global problem yes and do you see a chance that it does reach to a level uh closer to the Great Depression how bad does this get Charlie well nobody knows that because we've never done this before H it's we have a bigger credit bubble we have worse Foles more in interconnected global system if we responded to this one the way people responded to the 30s in my judgment it would be way worse I mean we would have a catastrophe and that you can argue gave us Hitler and World War Two and a lot of things that we didn't need I mean it was not you getting your financial integrity and the Integrity of your accounting right has enormous implications for the future of mankind and we and yet very few people realize how much we screwed up very few people realize even in leading law school schools and Business Schools how Enron never could have happened if they hadn't changed the accounting rules the accounting rules and what we have now is just a bigger widespread Enron you know I like I like telling my students that no civilization is greater than its plumbing and accounting is really the plumbing of the financial system and to the extent that uh the plumbing can't serve the function the whole the whole edifice really um in many situations uh is not going to work the way that it's intended idiot bubbles bless blessed by accountants are terrible for the whole civilization it would be much better if we didn't have these idiot bubbles or at least if they were dampened very considerably but people use the idiom nobody wants to take the punch bow away when everybody's having a good time at the party but that's the accountant's job and that's the central Banker's job and you're never popular doing that it's the business's job and the people who do it tend to be despised and hated and not a lot of people are willing to be despised and hated and ruin their fellow creatures parties etc the main thing you have to realize is Ben Franklin's basic idea that an ounce of prevention is worth a pound of cure that's understated an ons supervision is sometimes worth a ton of cure mhm and your only real chance was not to allow it to happen when they put in the options exchanges there was like one letter saying you shouldn't do this and War bu it wrote it mhm and he just said this is not doing any good for the whiter civilization we don't need this now you he was all alone and he was totally right when we separated banking from investment banking on the theory that investment banking had a natural proclivity to get a fair amount of neighb and Folly into it and that we wanted to protect our banks from the contagion that was a good idea when we created margin rules that discouraged heavy borrowing against Securities just to make more money when the Securities went up in value that was a good idea when they wanted to make the market system a better gambling casino as a side function of uh a necessary Capital Market with vast profits for the people who were helpers in the trade the market makers and the Brokers and so on that created a big constituency in favor of a dumb change and there was a little Warren Buffett saying this is a dumb idea we're not controlling margins if you're having option exchanges M you get unlimited leverage whatever comes automatically with an option exchange of course and then they did derivative trading which made the absence exchange look like a benign event and so just one after another we made these insane departures from the corrective devices we'd put in the last time we had a big trouble and that really work quite well the investment Banks of yore and the melons were running first Boston and Morgan Stanley was a very conservative place chasen by the 30s investment Banks were Partnerships they were totally private the partners were dependent for their retirement on the prosperity the firms they left behind and the customs and culture they left behind and the places were much more responsible and honorable the old first Boston company had this one of its early employees one of its employees a good friend of mine and when he went there in the early 50s they cared terribly about the consequences to their clients long term from the Securities they sold that ethos by the time the Year 2006 came along and pretty well disappeared now you and your partner um Warren Buffett have for years complained uh and warned about the dangers that you perceive in the modern derivatives markets the particularly credit derivatives uh you know also conser you also concerns about you know interest ratees swaps currency swaps Equity swaps but your real concern uh has been about the credit derivative Market well the interest rate swap had enormous dangers in it given the size it was on at and the accounting that was low but the credit default thing just went to new levels of excess from something that was already uh gross and wrong and uh what happened there was rather interesting in the 20s we had the bucket shop right and the bucket shop was a term of derision because these people ran a gambling parlor they didn't buy any Securities mhm they just enabled people to make bets against the house and the house furnished little statements of how the bets went out it was like the off trck Bing right until the house lost its money and all of a sudden disappeared yes or the house made its money and all of a sudden disappeared either way right but the bucket shop was regarded in retrospect at the end of the is a criminal Enterprise counterproductive to the nation derivatives trading with no Central clearing brought back the bucket shop but tell me because you could make bets without having any interest in the basic security and so and people did in the in the in the billions and billions and billions of dollars so we had a system in the professions and in the regulatory agent that and some of the most eminent and most admired people in finance including Greenspan argued that derivatives trading in the form of the old bucket shop was a great contribution to Modern economic Civilization now the Federal Reserve is working there's one word for this it's insane the problem that you're talking about now Charlie is really much bigger than just uh GMAC or will the government step in at General Electric have a look at the balance sheet of the Federal Reserve it has ballooned the Federal Reserve is today buying assets and I think they're probably doing what's absolutely necessary in order to keep liquidity flowing in the short term but they're buying assets today that they wouldn't even have considered looking at a year ago they're over $800 billion of this stuff sitting in the Federal Reserve balance sheet right now and that number in my view is much more likely to double or to approach $2 trillion uh within the next 18 months than any other number that you're likely to see well I think the problem is so extreme that nothing un Extreme has any chance of fixing it so I basically applaud the people in the government that are doing these extreme things I'm sure they're making a lot of decisions that in retrospect will be seen as mistakes but given The Human Condition where they have to do extreme things under Fire I am not inclined to criticize I like the fact that they are so willing to do things that have never been done before because believe you and me we have problems right we have never seen before War I so and I like the fact here I am a rightwing republican I like the fact that Obama has put into the White House Larry Summers who is a ferociously smart human being and will try and do the right thing even if it offends some people I think that's a quality that we need right now well you know you mentioned uh President elect Obama soon to be President Obama what do you think of the job that he's doing so far the transition team that he's put together directions that he's pointed that he's going to try to uh take the economy in well I would argue that he's given the circumstances and given the background he comes from I would argue that he is doing very well indeed and going back to your observation where you were supporting what the Federal Reserve is doing in terms of buying up all these assets swelling I comment on every individual decision but sure extreme aggression and trying to rent the total collapse of a system feeding on itself I think is totally correct MH and uh and I think that both Bernan and Summers are likely to understand that way better than most people would and I think we're very lucky to have both of them there gner I don't know but I have no feeling that he isn't a good member of the of the threesome now as people look at the situation that's currently evolving many people sort of see two problems in the short term there's a concern about deflation uh we have a mass massive contraction of credit formation there's deleveraging that's going on at a pace that nobody's ever experienced before unemployment is going to be rising very significantly uh the destruction of wealth on the private balance sheets unprecedented consumers are going to be spending less they're going to be trying to rebuild their own balance sheet um and clearly this is a situation where the government has got to come in strong and the government has got to come in heavy um do you have any views on the fiscal side of things the government's talking now about an $ 850 uh billion dollar package the mix of fiscal stimulus tax cuts and the like not only do we have to save the financial system in spite of our revulsion about the way many of its denisons behaved but we also need a huge a huge spending stimulus from the federal government I don't regard that as all bad at all I think there's a lot to be done in this country uh I think we need a whole electricity distribution system which is more efficient and bigger and more flexible and more perfect than we have and I think that this is an opportunity to get that done I think much can be done in medical care and I think the hospitals of the country are probably about to get a vast Improvement in their facilities and I think that's all to the good we have a whole lot of things that are worth doing Obama is not talking about scooping up people and having them stand around holding shovels in the middle of some Forest I mean he is talking about fixing infrastructure and so on uh you the city of Los Angeles where I live the streets are disgrace compared to the streets of Japan mhm Japan had so much fiscal stip stimulus you can't find a pothole on a side of a mountain in Japan but you can find but you can find lots of airports that nobody uses out in rural Japan that may be but at least they fixed all the streets and the trains and everything else so I welcome a fiscal stimulus that will now improve a lot of things but as part of the government's response the government in the United States and governments worldwide are printing money de facto at a rate that is absolutely unprecedented and if you know we know traditionally that if you increase the supply of something its price is going to go down short term everybody's really worried about deflation we would have been much better if we hadn't worked ourselves into this position where we have to do this and you are right to point out that there are dangers from what we have to do but the dangers from what we have to do are less than the dangers that would plainly come if we responded as we did to the 30s in an Ideal World of classical economics you can say just let everybody suffer and then let it work back itself from a low level we can't do that with a modern voting democracy we're hooked for exactly what is happening and so are the other Advanced Nations and sure there are dangers and we may get some inflation but uh but the kind of economic misery that gave us the rise of Adolf Hitler that we don't want and we should skirt that danger cheerfully accepting the dangers that come from the skirting so you see the situation as being one we're trying to manage the lesser of men of two we evils or the least of many evils as a practical matter and you know what I'm hearing from you Charlie is that so far so good it appears that the government is on a reasonable track it is very reasonable to react with the extreme Vigor that's been shown in fact I would argue in retrospect that the Vigor wasn't quite enough I would agree with you I would argue that it was PL perfect obvious they had to save all these Banks and the major investment Banks so in a scale so a scale of 1 to 10 how big a mistake was it that they let lhan go I don't think that would was a mistake interesting I think it actually helps to have one or two go I think you need some examples in a big mess and to just save everybody right no matter how awful they were uh that would have created just unlimited revulsion in the body politics so I think I think the people had to decide that some people were going to be saved and some people weren't and I think it was correct that they decided they'd have two categories the saved and the unsaved and I'm not going to quarrel with their decisions interesting I probably would have let Layman go too interesting even though the market seized up very dramatically afterwards and we had some of the most difficult short-term Financial consequences of that failure well we needed a total correction mhm was system that was evil and stupid we didn't need all our bright Engineers going into derivative trading and hedge funds and so on and so we had the civilization totally out of control well they're not going there in the future and we were not going to get out of that without a lot of mess and contraction and the mess and contraction was going to cause some operations to perish I knew Arthur Anderson Partners who were honest decent people and who suffered terrible in these situations other words the problem of moral hazard being so large that you really do you can't have a rule no matter how awful you are you're always going to be saved simply because you're big enough and you're connected enough no you have to have you have to have AOW failure for more please visit us at stanford.edu

In his words — from this talk

“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.”

Stanford Lawyer magazine, Spring 2009, "Q&A: Legal Matters with Charles T. Munger" (interview by Joseph A. Grundfest) · 2009

“One skill is knowing the edge of your own competency. It's not a competency if you don't know the edge of it. And Warren and I are better at tuning out the standard stupidities. We've left a lot of more talented and diligent people in the dust, just by working hard at eliminating standard error.”

Stanford Lawyer magazine, Spring 2009 (Issue 80), "Q&A: Legal Matters with Charles T. Munger" · 2009

“You can't save everybody. That would have created unlimited revulsion in the body politic. I probably would have let Lehman go, too.”

Stanford Lawyer magazine, Spring 2009 (Issue 80), "Q&A: Legal Matters with Charles T. Munger" (interview by Joseph A. Grundfest) · 2009

His explanation for why letting Lehman Brothers fail was not, in his view, a mistake.

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