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

A few days after the Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) shareholders meeting, Vice Chairman Charlie Munger did a short interview with CNNMoney. Asked about the state of the financial sector, he (as usual) held nothing back.

We would be better off if we downsized the whole financial sector by about 80%. I don't think the rest of us have anything to gain having massive trading between computers which try to outwit one another with their algorithms to the extent that when one succeeds, the rest of us are all paying for it. And why should we want to encourage our brightest minds to do what amounts to code-breaking and electronic trading? I think the whole system is stark-raving mad. Why should we want 25% of our graduating engineers going into finance? ... I don't see any social contribution.

But Berkshire has large investments in Wells Fargo (NYSE: WFC  ) and Goldman Sachs (NYSE: GS  ) . Isn't that hypocritical?

We buy the investments in the public market that are available. We don't tell the people running them what to do, and we don't allow our thoughts about what the law should be to change our investments. 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%.

I like Munger, but this seems like at least a partial cop-out. Munger has praised Goldman not just for the return Berkshire received from its investment, but for the bank's morality. Pressed last year, he eventually blamed Goldman's mishaps not on the bank's ethical code, but the legal code. "Goldman was in a world where Congress legalized all types of derivatives. It's an inherently dangerous world," he said last year. "Given that world, I see no reason to think Goldman misbehaved in some horrible fashion. Everyone was doing it, and it's only natural to increase your moneymaking activities when you can do so legally."

At any rate, let's put some numbers on this stuff. To get a sense of the magnitude of the problem, consider the profit growth of the financial sector compared with all other sectors:

Source: Bureau of Economic Analysis.

To put Munger's criticism into context, the important point here is not gawking at how much faster the financial sector has grown over other sectors. It's wondering how much faster other sectors would have grown if our best and brightest chose careers in engineering, medicine, or technology instead of derivatives trading. In one of the more depressing statistics to come from the academic world, financial engineering is now the most popular undergraduate major at Princeton's School of Engineering and Applied Science.

Munger is no doubt being hyperbolic when he says he'd shrink the financial sector by 80%, but not as much as you might think. Finance currently makes up about 8.5% of gross domestic product. In the 1960s, the figure was closer to 3.5%; in the late 1940s, it was around 2.4%. So even if today's financial sector were cut in half, its share of the economy wouldn't come close to breaking historical precedents. Cutting out one-third would bring the financial sector back to where it was in the mid-1980s.

There's an argument that growth in the financial sector has helped the broader economy, but this is controversial -- and unsubstantiated -- to say the least. As former Federal Reserve Chairman Paul Volcker once said, "I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth -- one shred of evidence." That evidence would not only have to point to growth, but growth so large that it compensates for the downsides of financial innovation, such as financial crises, deeper recessions, and bailouts. Good luck with that.

What do you think?

Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Berkshire Hathaway is a Motley Fool Inside Value recommendation and a Motley Fool Stock Advisor selection. The Fool owns shares of Berkshire Hathaway and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (24) | Recommend This Article (31)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 03, 2011, at 11:12 AM, phillies08 wrote:

    Couldn't agree with Munger more. Goes right to the point of Michael Lewis's book on derivatives, CDOs and the like. Computers trading with computers.

  • Report this Comment On May 03, 2011, at 11:51 AM, ronbeasley wrote:

    Completely agree with Munger, computers are trading against computers, and there is no regard for shareholders or society. But his cop-out is noteworthy. Its like saying, if the top home run hitters take steroids, its OK for you to do it to, even though they are unfair and damaging.

    Munger has always believed in investing in the world as it is, and so has Buffett. I cannot understand how they can separate what they claim to be their values from what they support financially. That seems very hypocritical.

  • Report this Comment On May 03, 2011, at 11:51 AM, midnightmoney wrote:

    Morgan,

    A. Please consider this quote from the Fool's annual trip to the Berkshire meeting:

    "On climate change: Numerous shareholders spoke during the business portion of the meeting regarding a Berkshire position on climate change. An exhausted Munger literally fell asleep after being subjected to a couple of speakers. Being a billionaire must be awesome." -- MF "Berkshire, 2011--Sokol, insults, and everything in between"

    Tongue in cheek as the above may or may not be, the quote says that making money allows an individual to turn his nose up, or down as it were, at addressing important issues. It says, when the topic moves away from financial issues, it's ok to tune out. I wonder how many people entering university are saying to themselves exactly the same thing--being a billionaire must be awesome--then going off and acting accordingly.

    B. What they are probably not asking themselves is, how can I help the economy at large? I'm wondering myself, thanks to your provocative question, what an individual (myself included) can do in terms of contributing to positive economic growth while also making a purely moral contribution to the world. I think that the act of making money and behaving in a proactively moral fashion are mutually exclusive insofar as turning a profit much much more often than not means someone less fortunate is being exploited.

    C. I would define moral behavior as that of individual who has considered the benefit to others before or while performing the act, and using that benefit--balanced with and against his own, and with and against that brought to the larger human population--as the motivation for acting.

    Not done yet--off for now to earn my keep. A very interesting article and a nice contribution to the economy at large!

  • Report this Comment On May 03, 2011, at 3:28 PM, smartmuffin wrote:

    Maybe he should start with himself. Young graduates get into finance for the same reason he did. To make money. They have no obligation to go become a doctor or an engineer or something "useful to society." Unless he's propsing some type of totalitarian state to arbitrarily limit the amount of finance-related jobs, what he's asking for is completely impossible. As long as there is money in trading stocks, people will trade stocks.

    Let HIM quit his job and go make a "social contribution."

  • Report this Comment On May 03, 2011, at 4:08 PM, TMFHousel wrote:

    ^ To be fair, Munger was a lawyer for decades before he entered the investment business (although one can argue whether lawyers add anything beneficial to society as well).

  • Report this Comment On May 03, 2011, at 5:40 PM, miteycasey wrote:

    Munger has always believed in investing in the world as it is, and so has Buffett. I cannot understand how they can separate what they claim to be their values from what they support financially. That seems very hypocritical.

    Just because you don't like the game doesn't mean you have to sit on the sidelines. All he's saying is I'm the best in the game, but I don't like the game. I wish we'd change the game.

  • Report this Comment On May 03, 2011, at 6:12 PM, ironyworks wrote:

    It's hard not to see the financial sector as primarily parasitic.

    It makes little, but money for the players...produces no food, forges no steel,catches no fish, builds no homes.

    Additionally, it's amoral.

  • Report this Comment On May 03, 2011, at 6:15 PM, BenLMoon wrote:

    Yes, Casey, but you and I can't change the game. Munger has the power to come a lot closer to changing the game...if he would try. Playing the game and whining a bit isn't trying to change it. Suppose he's only human not to take the challenge...but real statesmen in any pursuit take those challenges regardless of the personal pain. The rewards can sometimes be even greater, though.

  • Report this Comment On May 03, 2011, at 6:25 PM, twobeerjohn wrote:

    Buffet and Munger are both very self serving with their comments. Whichever way the wind is blowing for Berkshire today. Don't kid yourself, they are not as squeaky clean as they like to pass off. Ver self serving, very self serving.

  • Report this Comment On May 03, 2011, at 6:56 PM, Borbality wrote:

    They always say the right thing but it's easy to do when you're in their position.

  • Report this Comment On May 03, 2011, at 10:11 PM, CaptainWidget wrote:

    I couldn't disagree more fervently. Finance is the business of allocating extremely scarce resources to the places where they will make the most impact. The rise in the financial field simply indicates that capital is being more judiciously allocated than in the past, and with a higher likelihood for returning that investment and using the capital to increase value in some other area of society.

    The derivatives market is nothing more than a big info-market saying "this idea is safe with this amount of capital"

    Like SmartMuffin said....it's all well and good to say "things SHOULD be this way" but when rubber meets the road, if the only way to MAKE things that way is coercision, it's an awful idea. People enter finance because they want to. That's good enough for me.

  • Report this Comment On May 04, 2011, at 2:42 AM, alan0101 wrote:

    I agree with Munger, and add that he and Warren, apart from having the best experience base available, are very smart, unlike most WallStreet bankers, despite the bankers endless self-promotion as to how smart they are. They are not, they are salesmen with very good connections and too much clout. When intermediaries like Investment Bankers and lawyers play such and outsize role in business and society, you know things can't be right. Guess what? They are appalling and the whole debacle of the CDO, etc, new improved replay of the S&L of the 80's just prove it. Downsize by 80%, nobody will notice your absence. Things will get better!!

  • Report this Comment On May 04, 2011, at 4:14 AM, Kiffit wrote:

    9/1 would have cut the financial system somewhat, but unfortunately the back up systems that were introduced to counteract Y2K were in place and saved the finance sector infidels.

  • Report this Comment On May 04, 2011, at 8:08 AM, FinancialBistro wrote:

    Love Mungers comment. May be a bit extreme but the philosophy behind it is right on the money. A waste of talent however talent will flow where the money flows in many cases.

    Rick Coyle

    www.financialbistro.wordpress.com

  • Report this Comment On May 04, 2011, at 10:31 AM, ryanalexanderson wrote:

    Charlie Munger has the financial means to lobby for a Tobin tax on high speed transactions. Hell, Buffett could do it as part of the Gates Foundation - it's a worthy cause!

    The rest of us are forced to sit back and complain about an unfair system...but he has the chance to do something! Why doesn't he? He'd have some great allies - Ron Paul, Paul Volcker, etc...

    Well, Volcker, at least. Ron Paul may be opposed to any taxes.

  • Report this Comment On May 04, 2011, at 10:53 AM, Proletarian wrote:

    His statements juxtaposed with his praise of Goldman is not a copout at all. The morality he spoke of was a relative morality to other companies that are required to operate within a given framework. He is critical of the framework.

    He is clearly hating the game, and not the player.

  • Report this Comment On May 04, 2011, at 12:03 PM, stan8331 wrote:

    Absolutely agree with Munger. Finance must ENABLE production, not replace it. When rules are not in place to prevent it from replacing production, the end result will be the sort of massive bubble we just experienced, a house of cards destroyed by a moderate breeze. What's scary is that we seem to have learned nothing from the crisis - no rules have been put in place to prevent future financial bubbles from forming.

    I don't fault Berkshire for their financial investments - it makes no sense to tie one arm behind your back when competitors have no such handicap. Effective federal regulation that places the financial sector back in its proper role is the only solution, but I'm not optimistic it will happen until we have another, even worse collapse.

  • Report this Comment On May 04, 2011, at 3:24 PM, drborst wrote:

    Its easy to talk about downsizing the financial sector, and I suspect most would agree that downsizing would be a good thing (though 80% seems a bit extreem to me), but the question is, how?

    CaptainWidget is right to point out that finance does provide some benefit, but his last line about people wanting to go into finance doesn't ring true.

    Look through issues of Physics Today from the late 80s/early 90s, most have articles about going into finance that start with the reason to consider it. Defense R&D spending declined following the Reagan years, combined with the elimination of mandatory retirement for old tenured professors, meant that degree in Physics was worth a lot less than when you started college.

    So these guys went into finance to make a living, some made a ton of money and the kids entering college noticed, and now its a popular major. If the laws of supply and demand held in finance, Finance Today would start runing articles about using a finance degree in some 'non-traditional field',

    Oh, and Morgan, about your comment...

    >>^ To be fair, Munger was a lawyer for decades before he entered the investment business (although one can argue whether lawyers add anything beneficial to society as well). <<

    ..the same arguement could be made about financial commentators

  • Report this Comment On May 04, 2011, at 3:44 PM, CaptainWidget wrote:

    <<Absolutely agree with Munger. Finance must ENABLE production, not replace it.>>America is THE highest producer of goods in the world by some margin. I'd say the finance industry is doing a good job of enabling production.

  • Report this Comment On May 04, 2011, at 3:52 PM, bjasleep wrote:

    and to quote Lloyd Blankfein -- "but we do god's work."

  • Report this Comment On May 04, 2011, at 10:33 PM, bermuda999 wrote:

    1. Slap a .1% transaction tax on every share traded and witness the end of this financial shell game.

    2. Require that anyone purchasing Credit Default Swaps actually own the underlying instrument (to stop speculators from causing defaults by driving up the price to insure).

    3. Change reserve requirements so that banks can't mark to make-believe. Every complicated "asset" that isn't trivial to value gets a value of $0 on the books. Bye-bye obscure financial derivatives.

    I'm sure others have additional suggestions.

  • Report this Comment On May 04, 2011, at 11:48 PM, mimihoohoo2 wrote:

    No one can say for certain what is the highest use of our time on this planet . . . Not even the highly esteemed Charlie Munger. I do know that living in a wealthy country is better than not; and you cannot have a rich country without rich citizenry, who after all spend money on travel, restaurants, service industry products, and personal care products and leisure products: books, movies, skis, golf, tennis, aircraft, etc. Humans are not robots who are driven by the desire to be productive for its own sake. The altruistic, utopian experiment that is marxism failed miserably everywhere it was tried. It is pointless to stand back and judge the relative usefulness of men's pursuits: the professional golfer is no better or worse than the peace corps engineer building sanitary water systems for impoverished people. The point is that we are free to choose. Munger has just lost touch with reality. He lives in a bubble.

  • Report this Comment On May 05, 2011, at 10:06 AM, Handworn wrote:

    I like Munger too, but there's a perspective he's missing. There are three kinds of mastery. Mastery of self, mastery of your environment, and mastery of other people. The first is like when you take violin lessons or get a degree. The second is like buying a house or food or medical care. The last one is what the stock market and capitalism is about. With me so far?

    Munger is saying that only the first two have "social value." He's saying that catering to that last kind of mastery has grown too much. Which is basically the same as decrying war or political authority, which are also about mastering others. But really, it's the only kind of mastery that has no natural limits. Information is basically free, which means that you can master yourself as far as your character, self-discipline and so on will take you. Technology and manufacturing means that everyday stuff to master your environment with, including food, is so cheap we throw still-good examples away. So what's left?

    What he ought to be saying is that that third kind of mastery is what allows you to pursue the first two kinds, and that the real problem is not capitalism but its general mystification and condemnation in society such that relatively few people engage in it.

    More about that idea, which is called distributism, can be read in G.K. Chesterton's "The Outline of Sanity."

  • Report this Comment On May 07, 2011, at 5:06 PM, neamakri wrote:

    I agree with bermuda999.

    1% tax on trades would not hurt me at all, plus put some tax money against the national debt.

    Computer traders would have to add the 1% to their calculations. That would add a ton of stability, and stop bankers from playing stocks like they are in Las Vegas.

    Then stock purchases could be based on company value, not B.S. What a thought!

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