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Related previous post: Wesco Financial 1990 Letter
Showing posts with label Wesco. Show all posts
Showing posts with label Wesco. Show all posts
Thursday, April 2, 2009
Tuesday, July 15, 2008
Wesco Financial 1990 Letter
Great find by Dual_Bid on the MSN Berkshire Board.
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Also, if you own the latest edition of Peter Bevelin's Seeking Wisdom: From Darwin to Munger, check out page 268 where he gives Charlie's excerpt as a lesson on why bad lending happens so often. The current financial crisis provides further evidence of this and also shows the wisdom in Mark Twain's quote: "History doesn't repeat itself, but it rhymes." The present situation was very likely avoidable.
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Mr. Munger's insights on the lending business:
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Also, if you own the latest edition of Peter Bevelin's Seeking Wisdom: From Darwin to Munger, check out page 268 where he gives Charlie's excerpt as a lesson on why bad lending happens so often. The current financial crisis provides further evidence of this and also shows the wisdom in Mark Twain's quote: "History doesn't repeat itself, but it rhymes." The present situation was very likely avoidable.
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Mr. Munger's insights on the lending business:
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Granting the presence of perverse incentives, what are the operating mechanics that cause widespread bad loans (where the higher interest rates do not adequately cover increased risk of loss) under our present system? After all, the bad lending, while it has a surface plausibility to bankers under cost pressure, is, by definition, not rational, at least for the lending banks and the wider civilization. How then does bad lending occur so often?
It occurs (partly) because there are predictable irrationalities among people as social animals. It is now pretty clear (in experimental social psychology) that people on the horns of a dilemma, which is where our system has placed our bankers, are extra likely to react unwisely to the example of other peoples' conduct, now widely called "social proof". So, once some banker has apparently (but not really) solved his cost-pressure problem by unwise lending, a considerable amount of imitative "crowd folly", relying on the "social proof", is the natural consequence. Additional massive irrational lending is caused by "reinforcement" of foolish behavior, caused by unwise accounting convention in a manner discussed later in this letter. It is hard to be wise when the messages which drive you are wrong messages provided by a mal-designed system.
In chemistry, if you mix items that explode in combination, you always get in trouble until you learn not to allow the mixture. So also, in the American banking system. To us, a lot of foolish, unproductive lending and many bank insolvencies are the natural consequences, given existing American banking culture, of the combination of the following two elements alone:
(1) virtually unlimited deposit insurance; and
(2) uncontrolled interest rates on insured deposits.
These two elements combine to create a Gresham's law effect, in which "bad lending tends to drive out good." Then, if factor (3) below is added to an already unsound combination, we think deposit-insurance troubles are sure to be further expanded -- and not by a small amount:
(3) relatively unregulated, non-insured, low-cost "non-bank" banks.
Moreover, when the government starts suffering big deposit-insurance losses, if it continuously responds (in a natural, unthinking reaction) by raising deposit-insurance prices, we think it creates a "runaway-feedback" mode and makes its problems worse. This happens because the government, by adding even more cost pressure on banks, increases the cause of the troubles it is trying to cure. The price-raising "cure" is the equivalent of trying to extinguish a fire with kerosene.
Many eminent "experts" would not agree with our notions about systemic irresponsibility from combining (1) "free-market" pricing of interest rates with (2) government guarantees of payment. If many eminent "experts" are wrong, how could this happen? Our explanation is that the "experts" are over-charmed with an admirable, powerful, predictive model, coming down from Adam Smith. Those discretionary interest rates on deposits have a "free-market" image, making it easy to conclude, automatically, that the discretionary rates, like other free- market processes, must be good. Indeed, they are appraised as remaining good even when combined with governmental deposit insurance, a radical non-free-market element.
Such illogical thinking, displays the standard folly bedeviling the "expert" role in any soft science: one tends to use only models from one's own segment of a discipline, ignoring or underweighing others. Furthermore, the more powerful and useful is any model, the more error it tends to produce through overconfident misuse.
It occurs (partly) because there are predictable irrationalities among people as social animals. It is now pretty clear (in experimental social psychology) that people on the horns of a dilemma, which is where our system has placed our bankers, are extra likely to react unwisely to the example of other peoples' conduct, now widely called "social proof". So, once some banker has apparently (but not really) solved his cost-pressure problem by unwise lending, a considerable amount of imitative "crowd folly", relying on the "social proof", is the natural consequence. Additional massive irrational lending is caused by "reinforcement" of foolish behavior, caused by unwise accounting convention in a manner discussed later in this letter. It is hard to be wise when the messages which drive you are wrong messages provided by a mal-designed system.
In chemistry, if you mix items that explode in combination, you always get in trouble until you learn not to allow the mixture. So also, in the American banking system. To us, a lot of foolish, unproductive lending and many bank insolvencies are the natural consequences, given existing American banking culture, of the combination of the following two elements alone:
(1) virtually unlimited deposit insurance; and
(2) uncontrolled interest rates on insured deposits.
These two elements combine to create a Gresham's law effect, in which "bad lending tends to drive out good." Then, if factor (3) below is added to an already unsound combination, we think deposit-insurance troubles are sure to be further expanded -- and not by a small amount:
(3) relatively unregulated, non-insured, low-cost "non-bank" banks.
Moreover, when the government starts suffering big deposit-insurance losses, if it continuously responds (in a natural, unthinking reaction) by raising deposit-insurance prices, we think it creates a "runaway-feedback" mode and makes its problems worse. This happens because the government, by adding even more cost pressure on banks, increases the cause of the troubles it is trying to cure. The price-raising "cure" is the equivalent of trying to extinguish a fire with kerosene.
Many eminent "experts" would not agree with our notions about systemic irresponsibility from combining (1) "free-market" pricing of interest rates with (2) government guarantees of payment. If many eminent "experts" are wrong, how could this happen? Our explanation is that the "experts" are over-charmed with an admirable, powerful, predictive model, coming down from Adam Smith. Those discretionary interest rates on deposits have a "free-market" image, making it easy to conclude, automatically, that the discretionary rates, like other free- market processes, must be good. Indeed, they are appraised as remaining good even when combined with governmental deposit insurance, a radical non-free-market element.
Such illogical thinking, displays the standard folly bedeviling the "expert" role in any soft science: one tends to use only models from one's own segment of a discipline, ignoring or underweighing others. Furthermore, the more powerful and useful is any model, the more error it tends to produce through overconfident misuse.
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This brings to mind Ben Graham's paradoxical observation that good ideas cause more investment mischief than bad ideas. He had it right. It is so easy for us all to push a really good idea to wretched excess, as in the case of the Florida land bubble or the "nifty fifty" corporate stocks. Then mix in a little "social proof" (from other experts), and brains (including ours) often turn to mush. It would be nice if great old models never tricked us, but, alas, "some dreams are not to be." Even Einstein got tricked in his later years.
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Friday, May 9, 2008
Wesco 2008 Annual Meeting Notes
A big thanks to Peter Boodell.
The only duty of corporate executive is to widen the moat. We must make it wider. Every day is to widen the moat. We gave you a competitive advantage, and you must leave us the moat. There are times when it is too tough. But duty should be to widen the moat. I can see instance after instance where that isn’t what people do in business. One must keep their eye on ball of widening the moat, to be a steward of the competitive advantage that came to you. A General in England said, ‘Get you the sons your fathers got, and God will save the Queen.’ At Hewlett Packard, your responsibility is to train and deliver a subordinate who can succeed you. It is not all that complicated – all that mumbo jumbo. We make bricks in Texas which use the same process as in Mesopotamia. You need just a few bits of ethos, and particularly engineering ethos. Think through the system, and get a margin of safety.
Q13: Scott from LA. With portfolio of $2m, vs. that of Berkshire, how would your mandate be different? Small vs mid, us vs intl, etc?
If I was managing smaller money I’d be looking in smaller places, I’d look for mispricing. But I don’t want to change places with you. [laughter]
Q21: Matt from NYC. How does Berkshire thru its subsidiaries manage an annual budgeting process?
We don’t have one. Obsessing over budgets creates bad incentives. Just eliminate unnecessary costs. Budget committees tend to do just the opposite.
Q24: Ashok from LA. Checklist?
I don’t have a simple checklist. You have to work at it a long long time. I still do dumb things after years of hard work. The more big ideas you have the easier. We exclude a whole lot of things because they are in the too tough pile. If you exclude, you do better. Then you must have field where rationality will be rewarded. Some of political ideas – it is very hard to know how they will work out over next few centuries. We are not trying to involve ourselves. We look for things that can be done. But I have no little short list. People who sell strong abs on TV at night might have one. I have no rule for a strong brain.
Q29: I’m curious, you are student of history. Does today remind you of any time in past, and why?
I punched premium channel in hotel in Tokyo, and out came exercise in pornography. I would argue Soddom and Gomorah is still around. I think Athens of Pericles is still around today. Our bullies are similar to past eras.
Q40: CA. Average investor should invest in index funds.
All intelligent investing is value investing. Calling something a value fund doesn’t absolve it. You can call yourself a ballet dancer if you dance like me, but it is not a good thing. I wouldn’t recommend people broadly invest with any value fund. I would avoid funds that have 100% turnover per year. It is a ridiculous way for an ordinary index fund to behave. It is imperfect, but best outcome for most know-nothings, in order to avoid being misled by fools and liars.
Q45: What has changed since you first started investing?
I owe a great deal to Mr Buffett. It took a while to convince me. Warren and I together got very good at reinsurance transactions and portfolio transfers. We’ve learned together at it. Berkshire would have been a mess if it had ever stopped learning. Only reason we’ve been able to keep a shred of decency in our record is that we have been hell bent to keep learning.
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Book: Poor Charlie’s Almanack
The only duty of corporate executive is to widen the moat. We must make it wider. Every day is to widen the moat. We gave you a competitive advantage, and you must leave us the moat. There are times when it is too tough. But duty should be to widen the moat. I can see instance after instance where that isn’t what people do in business. One must keep their eye on ball of widening the moat, to be a steward of the competitive advantage that came to you. A General in England said, ‘Get you the sons your fathers got, and God will save the Queen.’ At Hewlett Packard, your responsibility is to train and deliver a subordinate who can succeed you. It is not all that complicated – all that mumbo jumbo. We make bricks in Texas which use the same process as in Mesopotamia. You need just a few bits of ethos, and particularly engineering ethos. Think through the system, and get a margin of safety.
Q13: Scott from LA. With portfolio of $2m, vs. that of Berkshire, how would your mandate be different? Small vs mid, us vs intl, etc?
If I was managing smaller money I’d be looking in smaller places, I’d look for mispricing. But I don’t want to change places with you. [laughter]
Q21: Matt from NYC. How does Berkshire thru its subsidiaries manage an annual budgeting process?
We don’t have one. Obsessing over budgets creates bad incentives. Just eliminate unnecessary costs. Budget committees tend to do just the opposite.
Q24: Ashok from LA. Checklist?
I don’t have a simple checklist. You have to work at it a long long time. I still do dumb things after years of hard work. The more big ideas you have the easier. We exclude a whole lot of things because they are in the too tough pile. If you exclude, you do better. Then you must have field where rationality will be rewarded. Some of political ideas – it is very hard to know how they will work out over next few centuries. We are not trying to involve ourselves. We look for things that can be done. But I have no little short list. People who sell strong abs on TV at night might have one. I have no rule for a strong brain.
Q29: I’m curious, you are student of history. Does today remind you of any time in past, and why?
I punched premium channel in hotel in Tokyo, and out came exercise in pornography. I would argue Soddom and Gomorah is still around. I think Athens of Pericles is still around today. Our bullies are similar to past eras.
Q40: CA. Average investor should invest in index funds.
All intelligent investing is value investing. Calling something a value fund doesn’t absolve it. You can call yourself a ballet dancer if you dance like me, but it is not a good thing. I wouldn’t recommend people broadly invest with any value fund. I would avoid funds that have 100% turnover per year. It is a ridiculous way for an ordinary index fund to behave. It is imperfect, but best outcome for most know-nothings, in order to avoid being misled by fools and liars.
Q45: What has changed since you first started investing?
I owe a great deal to Mr Buffett. It took a while to convince me. Warren and I together got very good at reinsurance transactions and portfolio transfers. We’ve learned together at it. Berkshire would have been a mess if it had ever stopped learning. Only reason we’ve been able to keep a shred of decency in our record is that we have been hell bent to keep learning.
………………..
Book: Poor Charlie’s Almanack
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