Warren Buffett and Charlie Munger, partners in Berkshire Hathaway, have finally come around to what Nassim Nicholas Taleb has been saying for years now. VAR models are dangerous, though they are taught widely in business schools and used on Wall Street. Mr. Munger even now talks about the risk of such mathematical theories being taught in business schools. While Mr. Buffett and Mr. Munger seem to be late to the game, better late than never -- I guess.
Perhaps Mr. Buffett needed to speak out now as the Oracle now that Berkshire lost big over the last year and a half, even its coveted triple-A credit score rating. Berkshire has a 24% stake in Moody's Investor Service, the credit scoring company that gave Wall Street companies that engaged in credit default swaps and the like triple-A ratings, even after it was obvious that such a rating was not deserved. Does this feel like collusion?
Some might wonder if Berkshire's rating did not go down until early this year because of its stake in Moody's. After all, Berkshire seems to have itself written complicated financial instruments that have been hammered for some time now. Berkshire has gone down 39% since December 2007. Oh, what a racket it all seems to be, even among the seemingly good guys. Because of this, the mere whiff of impropriety, the public's ire mustn't wane. Arianna Huffington has been hitting Wall Street banks hard and rightfully so!
Below Mr. Buffett and Mr. Munger speak about the dangers of mathematical theories, making clear their mistrust of the use of "higher-order mathematics in finance." But where were they before now? I have not heard them speak against such while Berkshire had its triple-A credit rating or when they were writing these complicated financial instruments. I don't mean to be accusatory, as I am most certainly no financial expert. But it all just feels so incredibly wrong right about now considering this harrowing time on Wall Street.
Here is Mr. Buffett on Moody's credit agency. But this too seems wrong, especially with Berkshires stake in Moody's. It also seems like a whole lot of people should go to jail. (The reference here is not specifically with regards to Mr. Buffet or Mr. Munger.)
"There is so much that's false and nutty in modern investing practice and modern investment banking, that if you just reduced the nonsense, that's a goal you should reasonably hope for," Mr. Buffett said. Regarding complex calculations used to value purchases, he said: "If you need to use a computer or a calculator to make the calculation, you shouldn't buy it."
Said Mr. Munger: "Some of the worst business decisions I've ever seen are those with future projections and discounts back. It seems like the higher mathematics with more false precision should help you, but it doesn't. They teach that in business schools because, well, they've got to do something."
Mr. Buffett said: "If you stand up in front of a business class and say a bird in the hand is worth two in the bush, you won't get tenure....Higher mathematics my be dangerous and lead you down pathways that are better left untrod."
Mr. Buffett was asked about Moody's which gave a triple-A rating of billions of dollars to mortgage backed securities that subsequently lost value.
Nassim Nicholas Taleb and Arianna Huffington are clear voices that can help guide us out of this Wall Street morass. Taleb's firm did not engage in such because "everyone else was doing it." Is this really an excuse for such? Sometimes even oracles are misguided. Who am I to say such a thing?
"Basically, four or five years ago, virtually everybody in the country had this model in their heads, formal or otherwise, that house prices could not fall significantly," Mr. Buffett said. He later added that "it was stupidity and the fact that everyone else was doing it."
He said that if Moody's had started to take a negative view on residential real estate, the ratings provider would have been hauled before Congress to testify about why it was hurting the U.S. economy with its bearish ratings. "They made a huge mistake, and the American people made a huge mistake," he said.