CHARLIE MUNGER 00:08
Eight. Now, this is a lollapalooza, and Henry Kaufman wisely talked about this, bias from over-influence by social proof, that is, the conclusions of others, particularly under conditions of natural uncertainty and stress. And here, one of the cases the psychologists use is Kitty Genovese, where all these people, I don’t know, 50, 60, 70 of them just sort of sat and did nothing while she was slowly murdered. Now one of the explanations is that everybody looked at everybody else and nobody else was doing anything, and so there’s automatic social proof that the right thing to do is nothing.
That’s not a good enough explanation for Kitty Genovese, in my judgment. That’s only part of it. There are microeconomic ideas and gain/loss ratios and so forth that also come into play. I think time and time again, in reality, psychological notions and economic notions interplay, and the man who doesn’t understand both is a damned fool.
Big-shot businessmen get into these waves of social proof. Do you remember some years ago when one oil company bought a fertilizer company, and every other major oil company practically ran out and bought a fertilizer company? And there was no more damned reason for all these oil companies to buy fertilizer companies, but they didn’t know exactly what to do, and if Exxon was doing it, it was good enough for Mobil, and vice versa. I think they’re all gone now, but it was a total disaster.
Now let’s talk about efficient market theory, a wonderful economic doctrine that had a long vogue in spite of the experience of Berkshire Hathaway. In fact one of the economists who won, he shared a Nobel Prize, and as he looked at Berkshire Hathaway year after year, which people would throw in his face as saying maybe the market isn’t quite as efficient as you think, he said, “Well, it’s a two-sigma event.” And then he said we were a three-sigma event. And then he said we were a four-sigma event. And he finally got up to six sigmas, better to add a sigma than change a theory, just because the evidence comes in differently. And, of course, when this share of a Nobel Prize went into money management himself, he sank like a stone.
If you think about the doctrines I’ve talked about, namely, one, the power of reinforcement, after all, you do something and the market goes up and you get paid and rewarded and applauded and what have you, meaning a lot of reinforcement, if you make a bet on a market and the market goes with you. Also, there’s social proof. I mean the prices on the market are the ultimate form of social proof, reflecting what other people think, and so the combination is very powerful.
Why would you expect general market levels to always be totally efficient, say even in 1973, 4 at the pit, or in 1972 or whatever it was when the Nifty Fifty were in their heyday. If these psychological notions are correct, you would expect some waves of irrationality, which carry general levels to … ’til they’re inconsistent with the reason.
Nine – What made these economists love the efficient-market theory is the math was so elegant, and after all, math was what they’d learned to do. To the man with a hammer, every problem tends to look pretty much like a nail. The alternative truth was a little messy, and they’d forgotten the great economist Keynes, whom I think said, “Better to be roughly right than precisely wrong.”
Perhaps, this is one of the reasons why investors need to have independent thinking.