Monday, December 31, 2007

Notes from the 3rd Annual New York Value Investing Congress by Marcelo Lima

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Jean-Marie Eveillard & Peter Bernstein on WealthTrack

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Sunday, December 30, 2007

CFA Conference Webcasts - Mauboussin and Zweig

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Oakmark Select - Update

The 2007 Legg Mason Symposium - Transcript

Thursday, December 20, 2007

At 71, Physics Professor Is a Web Star

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This article relates to Charlie Munger's Mental Model approach to life and learning, of course. From Mr. Munger's 1994 speech:
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You've got to have models in your head. And you've got to array your experience - both vicarious and direct - o­n this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and in life. You've got to hang experience o­n a latticework of models in your head.
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What are the models? Well, the first rule is that you've got to have multiple models - because if you just have o­ne or two that you're using, the nature of human psychology is such that you'll torture reality so that it fits your models, or at least you'll think it does. You become the equivalent of a chiropractor who, of course, is the great boob in medicine.
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It's like the old saying, "To the man with o­nly a hammer, every problem looks like a nail." And of course, that's the way the chiropractor goes about practicing medicine. But that's a perfectly disastrous way to think and a perfectly disastrous way to operate in the world. So you've got to have multiple models.
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And the models have to come from multiple disciplines - because all the wisdom of the world is not to be found in o­ne little academic department. That's why poetry professors, by and large, are so unwise in a worldly sense. They don't have enough models in their heads. So you've got to have models across a fair array of disciplines.
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You may say, "My God, this is already getting way too tough. "But, fortunately, it isn't that tough - because 80 or 90 important models will carry about 90% of the freight in making you a worldly-wise person. And, of those, o­nly a mere handful really carry very heavy freight.
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Books Related to Physics:
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Mr Tompkins in Paperback
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Einstein: His Life and Universe
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Isaac Newton
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Surely You're Joking, Mr. Feynman!
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What Do You Care What Other People Think?
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Genius: The Life and Science of Richard Feynman
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Six Easy Pieces: Essentials of Physics Explained by Its Most Brilliant Teacher
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Six Not-So-Easy Pieces: Einstein's Relativity, Symmetry, and Space-Time

In Search of Schrödinger's Cat: Quantum Physics and Reality
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The Martians of Science: Five Physicists Who Changed the Twentieth Century

First Eagle reopens two mutual funds

First Eagle joins Longleaf and Third Avenue in opening previously closed funds recently.
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Buy Bill Miller Now

Wednesday, December 19, 2007

A big deal: Poker is getting younger, cleverer, duller and much, much richer

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Books:
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Simons at Renaissance Cracks Code, Doubling Assets

Certainly not the Graham/Buffett/Munger type of value investor (Renaissance is all quant), but an interesting story nonetheless. What is also interesting is that if you search for RENAISSANCE TECHNOLOGIES CORP on the NASDAQ web site, it appears Renaissance's biggest purchase during the third quarter was Berkshire Hathaway (when you add up the A and B shares)!
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Thursday, December 13, 2007

Tulane 2005 Commencement Address - Michael Lewis

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"Do what you love before you figure out how much what you love is gonna cost you."

Value's Day Once More

Mark Sellers, Intelligent Investor - Motley Fool Interview

Wednesday, December 12, 2007

Berkshire Hathaway Is Poised to Surpass $150,000

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Wired for survival on the savannah

James Montier, a top-rated equity strategist who recently arrived at SocGen in London from Dresdner Kleinwort, has been educating clients for years with his reports on behavioural finance. These have now been gathered together in a 700-page tome, Behavioural Investing: A Practitioner's Guide to Applying Behavioural Finance (Wiley). It is quite simply the best and most comprehensive treatment of the subject to date.
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Behavioural finance suggests we overweight our personal, recent experience when arriving at judgments. We also tend to extrapolate from current circumstances into the future. Not only are we prone to overconfidence; we also seek out confirming evidence for our views. We attribute our successes to skill but our failures to bad luck. An ability to respond quickly to perceived danger was a successful strategy in our evolution. But as an investment strategy, fear is self-defeating. It leads to overreaction to irrelevant information and induces investors, who bought at the top of the market, to sell at the bottom.
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The best investors, like Keynes, seem not to have inherited these debilitating psychological traits. They are patient, operate with long time horizons and are prepared to tolerate periods of underperformance.

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Book: Behavioural Investing: A Practitioners Guide to Applying Behavioural Finance

Monday, December 10, 2007

An Investing Principles Checklist from Poor Charlie

From Poor Charlie's Almanack:
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An Investing Principles Checklist
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Risk – All investment evaluations should begin by measuring risk, especially reputational

  • Incorporate an appropriate margin of safety
  • Avoid dealing with people of questionable character
  • Insist upon proper compensation for risk assumed
  • Always beware of inflation and interest rate exposures
  • Avoid big mistakes; shun permanent capital loss
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Independence – “Only in fairy tales are emperors told they are naked”
  • Objectivity and rationality require independence of thought
  • Remember that just because other people agree or disagree with you doesn’t make you right or wrong – the only thing that matters is the correctness of your analysis and judgment
  • Mimicking the herd invites regression to the mean (merely average performance)
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Preparation – “The only way to win is to work, work, work, work, and hope to have a few insights”

  • Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day
  • More important than the will to win is the will to prepare
  • Develop fluency in mental models from the major academic disciplines
  • If you want to get smart, the question you have to keep asking is “why, why, why?”

-Intellectual humility – Acknowledging what you don’t know is the dawning of wisdom
  • Stay within a well-defined circle of competence
  • Identify and reconcile disconfirming evidence
  • Resist the craving for false precision, false certainties, etc.
  • Above all, never fool yourself, and remember that you are the easiest person to fool
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“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.”

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Analytic rigor – Use of the scientific method and effective checklists minimizes errors and omissions
  • Determine value apart from price; progress apart from activity; wealth apart from size
  • It is better to remember the obvious than to grasp the esoteric
  • Be a business analyst, not a market, macroeconomic, or security analyst
  • Consider totality of risk and effect; look always at potential second order and higher level impacts
  • Think forwards and backwards – Invert, always invert
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Allocation – Proper allocation of capital is an investor’s number one job
  • Remember that highest and best use is always measured by the next best use (opportunity cost)
  • Good ideas are rare – when the odds are greatly in your favor, bet (allocate) heavily
  • Don’t “fall in love” with an investment – be situation-dependent and opportunity-driven
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Patience – Resist the natural human bias to act
  • “Compound interest is the eighth wonder of the world” (Einstein); never interrupt it unnecessarily
  • Avoid unnecessary transactional taxes and frictional costs; never take action for its own sake
  • Be alert for the arrival of luck
  • Enjoy the process along with the proceeds, because the process is where you live
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Decisiveness – When proper circumstances present themselves, act with decisiveness and conviction
  • Be fearful when others are greedy, and greedy when others are fearful
  • Opportunity doesn’t come often, so seize it when it comes
  • Opportunity meeting the prepared mind; that’s the game
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Change – Live with change and accept unremovable complexity
  • Recognize and adapt to the true nature of the world around you; don’t expect it to adapt to you
  • Continually challenge and willingly amend your “best-loved ideas”
  • Recognize reality even when you don’t like it – especially when you don’t like it
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Focus – Keep things simple and remember what you set out to do
  • Remember that reputation and integrity are your most valuable assets – and can be lost in a heartbeat
  • Guard against the effects of hubris and boredom
  • Don’t overlook the obvious by drowning in minutiae
  • Be careful to exclude unneeded information or slop: “A small leak can sink a great ship”
  • Face your big troubles; don’t sweep them under the rug
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In the end, it comes down to Charlie’s most basic guiding principles, his fundamental philosophy of life: Preparation. Discipline. Patience. Decisiveness.

Whitney Tilson on Wealthtrack

http://www.wealthtrack.com/video_player.html

Understanding The Numbers

Friday, December 7, 2007

Martin Capital Management - 2006 Annual Report

Like the Buffett discussion on derivatives I posted a couple of days ago, I think it is also a good time to go back and review Frank Martin's discussion from MCM's 2006 Annual Report:
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To review previous Annual Reports, click HERE.
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Fall 2007 — CIO interview with Chuck Royce Q307

The Structure of “Unstructured” Decision Processes - 1976 Paper

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This paper defines a decision as a specific commitment to action (usually a commitment of resources) and a decision process as a set of actions and dynamic factors that begins with the identification of a stimulus for action and ends with the specific commitment to action. Unstructured refers to decision processes that have not been encountered in quite the same form and for which no predetermined and explicit set of ordered responses exists in the organisation. And strategic simply means important, in terms of the actions taken, the resources committed or the precedents set. This paper uses empirical research to suggest a basic framework that describes unstructured, strategic decision processes. The suggested framework embodies the results of our own study of 25 such decision processes, as well as evidence from published empirical studies.

Wednesday, December 5, 2007

Warren Buffett on Derivatives – from 2005 Berkshire Hathaway Letter to Shareholders

In light of recent events, I thought it may a good time to review the brief discussion on derivatives from Mr. Buffett in his 2005 letter to shareholders. Many companies, executives, analysts, and members of the media are claiming that current derivatives losses were unforeseen and totally unpredictable. Mr. Buffett and Mr. Munger have been warning of these "unpredictable" events for YEARS. I'd be willing to bet that they'd also predict there is still a whole lot more that has yet to come home to roost.
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Warren Buffett on Derivatives – from 2005 Berkshire Hathaway Letter to Shareholders:
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Long ago, Mark Twain said: “A man who tries to carry a cat home by its tail will learn a lesson that can be learned in no other way.” If Twain were around now, he might try winding up a derivatives business. After a few days, he would opt for cats.
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We lost $104 million pre-tax last year in our continuing attempt to exit Gen Re’s derivative operation. Our aggregate losses since we began this endeavor total $404 million.
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Originally we had 23,218 contracts outstanding. By the start of 2005 we were down to 2,890. You might expect that our losses would have been stemmed by this point, but the blood has kept flowing. Reducing our inventory to 741 contracts last year cost us the $104 million mentioned above.
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Remember that the rationale for establishing this unit in 1990 was Gen Re’s wish to meet the needs of insurance clients. Yet one of the contracts we liquidated in 2005 had a term of 100 years! It’s difficult to imagine what “need” such a contract could fulfill except, perhaps, the need of a compensation conscious trader to have a long-dated contract on his books. Long contracts, or alternatively those with multiple variables, are the most difficult to mark to market (the standard procedure used in accounting for derivatives) and provide the most opportunity for “imagination” when traders are estimating their value. Small wonder that traders promote them.
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A business in which huge amounts of compensation flow from assumed numbers is obviously fraught with danger. When two traders execute a transaction that has several, sometimes esoteric, variables and a far-off settlement date, their respective firms must subsequently value these contracts whenever they calculate their earnings. A given contract may be valued at one price by Firm A and at another by Firm B. You can bet that the valuation differences – and I’m personally familiar with several that were huge – tend to be tilted in a direction favoring higher earnings at each firm. It’s a strange world in which two parties can carry out a paper transaction that each can promptly report as profitable.
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I dwell on our experience in derivatives each year for two reasons. One is personal and unpleasant. The hard fact is that I have cost you a lot of money by not moving immediately to close down Gen Re’s trading operation. Both Charlie and I knew at the time of the Gen Re purchase that it was a problem and told its management that we wanted to exit the business. It was my responsibility to make sure that happened. Rather than address the situation head on, however, I wasted several years while we attempted to sell the operation. That was a doomed endeavor because no realistic solution could have extricated us from the maze of liabilities that was going to exist for decades. Our obligations were particularly worrisome because their potential to explode could not be measured. Moreover, if severe trouble occurred, we knew it was likely to correlate with problems elsewhere in financial markets.
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So I failed in my attempt to exit painlessly, and in the meantime more trades were put on the books. Fault me for dithering. (Charlie calls it thumb-sucking.) When a problem exists, whether in personnel or in business operations, the time to act is now.
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The second reason I regularly describe our problems in this area lies in the hope that our experiences may prove instructive for managers, auditors and regulators. In a sense, we are a canary in this business coal mine and should sing a song of warning as we expire. The number and value of derivative contracts outstanding in the world continues to mushroom and is now a multiple of what existed in 1998, the last time that financial chaos erupted.
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Our experience should be particularly sobering because we were a better-than-average candidate to exit gracefully. Gen Re was a relatively minor operator in the derivatives field. It has had the good fortune to unwind its supposedly liquid positions in a benign market, all the while free of financial or other pressures that might have forced it to conduct the liquidation in a less-than-efficient manner. Our accounting in the past was conventional and actually thought to be conservative. Additionally, we know of no bad behavior by anyone involved.
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It could be a different story for others in the future. Imagine, if you will, one or more firms (troubles often spread) with positions that are many multiples of ours attempting to liquidate in chaotic markets and under extreme, and well-publicized, pressures. This is a scenario to which much attention should be given now rather than after the fact. The time to have considered – and improved – the reliability of New Orleans’ levees was before Katrina.
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When we finally wind up Gen Re Securities, my feelings about its departure will be akin to those expressed in a country song, “My wife ran away with my best friend, and I sure miss him a lot.”

Monday, December 3, 2007

Friday, November 30, 2007

Eddie Lampert Issues Letter to Sears Associates

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Arne Alsin: No pretty bow, but still a gift

Arne Alsin: The rational investor looks beyond price

The Entrepreneurial Investor

A logical investor must take irrational market behavior into account when choosing stocks to buy, sell, and hold. Fear and euphoria cannot dominate the actions of someone who really knows the companies and industries in which he or she invests, but other people’s fear and euphoria should influence one’s choices. Do not blindly follow the herd, but pay close attention to its movements. Opportunity exists in the gap between a company’s value and the herd’s perception of its value. Of course, it can take a long time for the herd to catch up, but that is how an entrepreneurial investor’s patience is rewarded.
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Thursday, November 29, 2007

Tweedy, Browne's Semi-Annual Report

In a fascinating new book, A Demon of Our Own Design, author Richard Bookstaber, a “Wall Streeter” with over 20 years of quantitative trading experience, contends that financial innovation, complexity and globalization have combined to make our markets more crisis prone. He uses biology as a frame of reference for economic behavior, and contrasts the cockroach and the furu, a small perch-like fish, in a case study of risk management. He finds the survival of the cockroach over millions of years quite remarkable, especially in light of what he describes as their “coarse and sub-optimal behavior” when it comes to risk management. In essence, the cockroach has a rather simple defense mechanism: moving away from slight puffs of air. It completely ignores a wide range of other information and risks “…that one would think an optimal risk management system would take into account.”
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He contrasts the sub-optimal behaving cockroach to the finely tuned and optimizing behavior of the furu, a once dominant, small, perch-like fish that survived in Africa’s Lake Victoria for thousands of years. The furu, over the centuries, became highly adapted to its environment, evolving into some 300 species and developing a myriad of skills, which allowed it to thrive and flourish in its habitat, rivaling “the finches that Darwin studied in the Galapagos.” It unfortunately fell victim to extinction when the Nile Perch was introduced by a Kenyan game fisheries officer into the lakes of Central Africa. Bookstaber points out that their “extinction was not the result of natural selection based on fitness in the usual sense; they were diverse and suited for almost every conceivable element of the Lake Victoria ecology.…Its path toward extinction was just a result of dumb luck that someone had introduced an alien species into its waters.”
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The furu, on the other hand, is akin to today’s highly leveraged investor seeking to eradicate risk by fine tuning portfolios using probability theory in an attempt to ferret out and nullify any and all conceivable risks. Portfolios of high alpha generating, non-correlated assets are put together in a mosaic that is supposed to enhance return and lower volatility. With risk so theoretically constrained, investors are free to use leverage to exploit small market inefficiencies, allowing them to proverbially and safely “pick up dimes in front of steamrollers.” With massive amounts of individual and institutional capital having moved into these finely-tuned and highly leveraged strategies, Bookstaber contends that our capital markets will from time to time be confronted with liquidity shocks that could accelerate into full blown crises. Such was the case with the credit crunch in August.

Annaly - Note on Freddie Mac Following Release of its 3rd Quarter Results

Another (see post below on Pzena) opinion on Freddie Mac:
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Long-Term Value in Freddie Mac

FPA Capital Fund's Semi-Annual Report

In light of the above comments, we believe the odds of a 2008 recession have increased to at least 50%, or more. Given the growing credit contraction, oil prices approaching $90 per barrel and the dollar setting new alltime lows versus a basket of currencies; future Fed policy actions may prove rather ineffectual in dealing with these challenges. We are of the opinion that the Fed will lower the Fed Funds rate into the 3.75% to 4% range next year, or lower, as housing, capital markets and consumer issues negatively affect economic and corporate earnings growth. We view consensus earnings growth expectations as being too high and believe that they will have to be lowered. Only recently have various types of financial services companies begun to recognize their problem loans and investments, with charges and provisions for future losses. Some of these stocks have responded favorably, with the belief that these companies are getting their problems behind them. Again, we believe the consensus is being too optimistic. Generally, managements are always initially optimistic, until they have to face the grim reality of the situation, and this process should extend well into 2008. The stock market appears to be ignoring these various risks since there appears to be a general belief that lower interest rates will ride to the rescue to solve these credit problems and support stock prices. We do not agree with this optimistic view and, therefore, we will continue to deploy a highly defensive portfolio strategy since we do not believe we are being appropriately compensated for these risks.

Wednesday, November 28, 2007

LeBron Inc. - The building of a billion-dollar athlete

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Wouldn't it be interesting if LeBron used LRMR (see article) the way Mr. Buffett has used the insurance business to build a diversified holding company? For LeBron, the return on capital for that business is ridiculously high while he is in his prime and if he lets all that cash build up, gets someone with capital allocating expertise to partner with, and then either invests in and/or buys businesses when they are cheap, he could have pretty sizable conglomerate by the time he retires.
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And in full disclosure, I grew up in the Cleveland area and am a big Cavs fan. That fact also makes me hope that Mr. Buffett's decision to stay in his home town of Omaha also rubs off on LeBron and he spends his entire career in Cleveland!

Another “Friendly” Deal? - by Phillip Ristau

Tuesday, November 27, 2007

What Makes Warren Buffett Successful?

Incentive-caused Bias in the Medical Profession

An excellent post from the blog of Sanjay Bakshi:
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Mr. Charlie Munger would surely have enjoyed reading this superb article in New York Times Magazine published on 25 November.
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The piece titled, "Dr. Drug Rep", is a moral story of Dr. Daniel Carlat, a medical man, who learnt how to deal with one of Mr. Munger's favorite mental models: Incentive-Caused Bias which Mr. Munger likes to describe as "whose bread I eat, his song I sing."
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Every professional should read Dr. Carlat's story. It has powerful lessons for professions outside of medicine...
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Mr. Munger likes to talk about incentive-caused bias as a very powerful psychological tendency, which makes, "a decent man, driven both consciously and subconsciously, by incentives, drift into immoral behavior in order to get what he wants."
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Its fascinating to me to see what happens once incentive-cause bias sets in.
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After his immoral behavior has started, the victim would come under the influence of several more psychological tendencies. For example, Operant Conditioning (It feels good, so I want more), Social Proof (everyone is doing it, so it must be OK), bias from Commitment and Consistency principle (I have to be consistent with my earlier, taken stand), and Low contrast effect (If I said yes to x, then saying yes to 1.01 x is no big deal) would combine together to produce rationalized immoral behavior. ("Man is not a rational animal, but a rationalizing one.")
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It takes a lot of courage for a professional to speak out against the incentive caused bias spreading like cancer in his profession, which is exactly why such stories deserve to be recommended for reading...
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For example, the accounting profession could do with more Dr. Carlats...
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Article: Dr. Drug Rep