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As the financial crisis of 2008 recedes into memory it seems that many of the lessons have been learned well enough. We now have Basel 111, Dodd-Frank and the Volcker rule. These reforms aim to tackle the problems that caused the last crisis. But will they stop the next crisis when – not if – it happens?
I do not think so – for the simple reason that in my opinion these reforms do not go to the heart of the matter. The biggest part of the problem is the flawed humans who operate our financial system. If we want to avoid, or at least minimise the next bust and if want capitalism to work better we need to come to grips with our own flawed minds.
Business schools, through their MBA programmes have done much to improve business competence. However, based on my experience of the financial crisis, if I was asked to choose between my MBA business school education and the one I received through my readings of Warren Buffett and Berkshire Hathaway I would probably choose the latter.
Why? Because in spite of some great exceptions, the teaching of finance has not changed. I recently checked leading business schools’ finance curricula and saw that they still have their heads full of the capital asset pricing model. They are still teaching their students topics such as how to calculate precisely a company’s weighted average cost of capital – down to a tenth of a per cent.
In addition to being based on the patently false assumption that risk in a stock is based on its price volatility, the implicit idea that finance is about calculating something down to a tenth of a percentage point is entirely wrong. It means that we are still educating a generation of students who implicitly believe that they can calculate the precise cost of everything, whereas in fact they know the value of nothing. We do not want our financial system to be run by finance types who think that our financial system can be precision engineered down to a decimal point, inexorably pushing us to a potential critical point where it might all fail all over again – as it did in 2008.
However, business schools continue to populate our financial system with quasi-engineers with minds that more closely resemble finely tuned Ferraris, when what is needed are robust 4x4s. To date, I know of very few courses at business schools that have adopted a more practical and robust approach to finance.
This is not good enough. We need our finance MBAs to be practical humanists. The core of the curriculum in our MBA finance courses should be learning to understand our own human fallibility.
MBA programmes should be turning out modern day practical philosophers who understand the vicissitudes of human affairs and who have a strong sense of their own, all-too-human failings. They should be imbued with ideas such as margin of safety and the irrationality of the market. Of how the economic and financial world is best understood as a complex and unpredictable adaptive system which individuals will never be able to predict, or measure precisely.
Business schools, and especially their finance departments, need to do better. The core of the matter, and the real reason why we have had and will continue to have financial crises, is because of our faulty human wiring. Business school education needs to come to grips with this reality and address it head on.
All students of finance should be taught the lessons from investors such as Ben Graham, Warren Buffett and Charlie Munger and the Santa Fe Institute, the not-for-profit research centre.
From my perspective, it is only when the broad mass of business school graduates, especially the ones who major in finance, have understood and internalised these teachings – and understand the need for a margin of safety, that I will be sure that we have successfully and permanently improved our capitalist system.
Guy Spier is the author of The Education of a Value Investor and runs the Aquamarine Fund.