Justice is done.

I was doing research and I came on a talk given by Charles Munger, the long-time partner of Warren Buffett. I had read the speech given at the University of Californa, Santa Barbara several years ago. It's a delight to read and think about. On a day that Bernie Madoff got sentenced to 150 years in jail one section stood out: His discussion of "febezzlement."

Munger calls the fees and other charges imposed by actively managed mutual funds and other investment managers "febezzlement." (Try and say that fast three times.) In his talk, Munger reminded his audience that the economist John Kenneth Galbraith had come up with the term "bezzle" to describe the outright frauds--think Bernie Madoff and Alan Stanford--that go on for years undetected when markets are strong, only to be revealed during a bear market.

Well, Munger invented the word febezzlement" for the practice of charging high fees during the good times. "I considered the billions of dollars totally wasted in the course of investing common stock portfolios for American owners," said Munger. "As long as the market keeps going up, the guy who's wasting all this money doesn't feel it, because he's looking at these steadily rising values. And to the guy who is getting the money for investment advice, the money looks like well earned income, when he's really selling detriment for money, surely the functional equivalent of undisclosed embezzlement."

Economist Paul Krugman's worries that when the U.S. economy emerges from recession the recovery will be reminiscent of Japan's "lost decade". The Japanese economy stagnated for years following the bursting of its real estate and stock market bubbles in 1989.

Here's my question: Has the U.S. already lived through a "lost decade"?

1) Standard & Poor's points out that the stock market is 39% from Dec. 31, 1999. The last negative decade was the 1930s. Annualized, stocks lost 5.12% so far this decade; in the 1930s they lost 5.26%.

2) The decade's gains in residential real esate are almost gone.

3) I got the stock market numbers from David Henry of BusinessWeek at his blog, Unstructured Finance. He writes: "Some people said we should call this decade the oughts, for the two zeroes. The term didn't catch on. Looking back, it is clear that the real oughts of the 2000s were that we ought not to have paid so much for internet stocks and that we ought not to have paid so much for big houses with granite counter-tops."

4) It has been a lost decade for private sector jobs, too. In a very important post, Mike Mandel of BusinessWeek on his blog calculates notes that between "May 1999 and May 2009, employment in the private sector sector only rose by 1.1%, by far the lowest 10-year increase in the post-depression period." Look at this chart and weep:

5) Real median household income is down for the decade.

My answer: It's has been a lost decade. If Krugman's right, we're actually entering into our second lost decade.

Numerous scholarly studies have documented the relative poor performance of professional money managers compared to the market averages, such as the Standard & Poor's 500. In essence, about 80% of professional money managers do worse than the main benchmark indexes. "'When someone says, 'I intend to beat the market,' the market he is talking about is not some neutered beast; it's the sum of all the smartest, toughest minds in this business," says Charles Ellis, the long-time pension and investment consultant. "When you come to market to sell, the only buyers you'll find are the ones who are thrilled that you just came into the cross hairs on their sniper scopes." Rex Sinquefield, a long-time finance maven, famously remarked: "There are three classes of people who do not believe that markets work: the Cubans, the North Koreans, and active managers." (It looks like Cubans are opening up more to markets, so in the future it may just be the two classes.)

Of course, the typical Wall Street response is to invest with the small number of actively managed mutual funds that do well over time. Some people do consistently beat the market. Look at Warren Buffett, the Sage from Omaha. Shareholders in his holding company Berkshire Hathaway have earned a compound average annual gain of 20.3% from 1965 through 2008. That's double the 10.3% performance of the main market benchmark, the Standard & Poor's 500-stock index--even after a disastrous 2008 for Berkshire Hathaway.

I'm not going out on a limb when I say conventional wisdom is right: Buffett is an investing genius. If you enjoy basketball like I do, he's the money equivalent of Michael Jordan, LeBron James and Kobe Bryant all rolled into one. He has what Sir Winston Churchill called "the seeing eye, the ability to see beneath the surface of things, to know what is on the other side of the brick wall, to follow the hunt three fields before the throng." Still, there's a mystery at the core of what Buffett does. His investment methods and philosophy are well known. He lays them out in clear language and folksy anecdotes in his widely-read annual letter to shareholders. His exploits have been covered in depth over the years in books, magazine articles and newspaper profiles. Yet he still leaves everyone else far behind in the investment sweepstakes.

Yet there's a critical element to what he does that even he can't explain. Nobel laureate Paul Samuelson says that John Maynard Keynes--himself an astute investor--once said, "Really, you should buy one stock at any one time. The best one going. And when it's no longer that, replace it by the new best." Well, silly as those sentences sound it pretty much sums up what Buffett has done in the postwar era. It's a trick few of us can emulate.

The question is, can you pick the next Warren Buffett to manage your money when he is just starting out in the business? Who among the thousands upon thousands of men and women just starting their professional careers managing money in mutual funds, managed accounts or some other type of investment vehicle will be the next Buffett? The odds are that at least a handful will consistently beat the market over the next half century and that if you invest with him or her in their 20s you'll pocket a handsome sum of money by the time they reach their 60s. But who? The boilerplate is right: Past performance is no guarantee of future performance. It's as hard--if not harder--to pick the next superstar as it is to choose a stock that will soar in value year after year.

One of my favorite stories is about Warren Buffett. Somebody had moved to Omaha, and a neighbor came by to say hello. He had big glasses and wore a well-worn suit. He asked if the neighbor wanted to invest with him. He managed some money. Well, there was no way he was going to invest with this unpreposssing person.

That person was Warren Buffett. If he had invested with him he would have been a millionaire several times over.

I was reminded of this story the other day when I was searhing through some old emails. I came across this one. I had told this story on the radio:

Hi Chris,

.... I enjoyed your Warren Buffett anecdote about the neighbor who turned Buffett's investment proposal down. From reading Roger Lowenstein's marvelous book, "Buffett: The Making of an American Capitalist", I can tell you that the neighbor may well have been Tom Keough, who later became President of Coca Cola. Keough was a neighbor of Buffett's in Omaha for a short time in the late 1950's, and according to Lowenstein declined Buffett's invitation to join the Buffett Partnership. But so did a lot of other neighbors and friends...

For most of us, indexing is the way to go.

Jason Zweig, the market columnist for the Wall Street Journal, has a nice tribute to the late Peter Bernstein. You can read it here.

The theme of Bernstein's work was risk and uncertainty. How do we deal with it? How do we cope with risk. How do we manage risk.

Late in his life, Mr. Bernstein often joked that he had made his living for decades by repeatedly "telling people what they know only too well already."

Also in 1970, Mr. Bernstein wrote: "We simply do not know what the future holds." Over the ensuing decades, he returned again and again to that phrase in his speeches, articles and books, because he felt it captured the central truth about investing.

It's a profound insight. Its why most people should match up their savings with their goals, and not try to beat the market and not get caught up in the latest market fad or fall into a deep funk during a bear market.

This comes from David Rosenberg. he used to be chief economist at Merrill Lynch. He is now with Gluskin Sheff. Rosenberg always finds intriguing trends to highlight. This one is striking.

What really struck us in the employment report of a few weeks ago was the fact that the only segment of the population that is gaining jobs is the 55+ age category. This group gained 224,000 net new jobs in May while the rest of the population lost 661,000. In fact, over the last year, those folks 55 and up garnered 630,000 jobs whereas the other age categories collectively lost over six million positions. This is epic.

Moreover, the number of 55 year olds and up who have two jobs or more has risen 1.1% in the last year, the only age cohort to have managed to gain any multiple jobs at all. Remarkable. These folks have seen their wealth get destroyed by two bubble-busts less than seven years apart ...

He's right. This is epic. Is this more evidence that the postwar trend toward earlier and earlier retirement is reversing. I think so. The other thing: Are employers more willing to hire experienced workers these days in light of a reasonable forecast of weak demand for yars to come. In other words, experience is less of a handicap because it's easier to wring out productivity improvements from older workers:? If so, is this a factor in the very weak job market for recent college graduates? My guess is yes.

Remember the famous career advice scene in the 1967 movie The Graduate? A businessman buttonholes Benjamin Braddock, the recent college graduate played by Dustin Hoffman, and imparts his wisdom of how to get ahead with one word: Plastics. At the time it was the leading edge of an industrial economy where wealth creation meant making tangible things.

Contrast that job counsel to the career prediction of Hal Varian, chief economist at Google. In an interview with McKinsey & Co. late last year, Varian remarked that "the sexy job in the ten years will be statisticians." In a word: Statistics. It's the kind of job that flourishes in an economy led by idea-driven, knowledge-based, conceptual companies in biotechnology, healthcare information systems, web-based search engines and the like.

Bud Hebeler of Analyzenow.com sent out a note about a presentation he gave at a real estate seminar. I'm a big fan of his website and conservative financial advice. He offers an important cautionary note at a time when I am hearing more and more people interested in getting back into the real estate speculation business. (It's a good time to look for a home, a primary residence; the caution is about real estate investing or speculation.)

The remainder of the presentations were from my friend who talked about his own experiences with investment real estate, followed by a local banker who talked about lending, followed by a real estate brokerage manager, and last a property manager.

The problem I saw was that you'd have to own many houses to reduce the risk within the real estate part of a portfolio. I'll stick with buying REITS when I feel it's time to get back into the real estate market--and I continue to hope that the last of my real estate partnerships will sell someday before I die.

I agree. The risk is far too concentrated for most people. Real estate investment trusts or REITS are a far more cost effective and sensible way to add real estate exposure.

Here is my puzzlement. First, we live in an era when everyone from the President to the head of the local Chamber of Commerce realizes that human capital is the most valuable resource. It's knowledge, skill, hustle, risk-taking that create value in a competitive marketplace. The future belongs to brains, not brawn. There's nothing conroversial in this insight.

Second, from Warren Buffett to David Swensen good investors pick up valuable assets on the cheap during bad times so that they can pocket outsized profits when the good times roll.

So, wouldn't you think that companies would be loading up on newly minted college grads that can be had for cheap, as well as out of work engineers, high-tech workers, etc? Apparently not, according to the Economic Policy Institute.

The latest unemployment data for young college graduates--workers with a bachelor's degree or higher who are under 27 years old--show that 2009 is the second worst year on record at 5.9%, barely behind 1983's 6.2%. Workers with higher education are generally better insulated from downturns in the labor market and the economy than those without a college education. Historically, they have lower unemployment rates than the total population. However, the unemployment rate among college graduates aged 23-27 has jumped up significantly during this recession. Layoffs and hiring freezes continue as employers try to weather the recession and entry-level openings are hard to find.

Of course, college grads are doing better in the job market than those with less education. The rewards to education remain high. Nevertheless, it seems that an investment opportunity is being lost by companies.

One of my favorite blogs is by Bruce Nussbaum at Business Week. He has an intriguing post on company leadership.

CEO Legacies: A.G. Lafley Vs. Bob Nardelli
Posted by: Bruce Nussbaum on June 09

Lafley opened up P&G to new networks of innovation, tools of empathy and synergies between silos. Nardelli repeated what he learned at General Electric, applying worn-out mathematical measurements inside two companies based on cultures of service and consumer understanding.

Executive suites are far too full of Nardelli's and not enough Lafley's.

It sure looks like the recovery--when it comes--could be poor at generating jobs. It isn't just the high unemplpyment rate. It's the large number of marginally employed and underemployed works. This paper from the Federal Reserve Bank of San Francisco lays out the pessimistic case. It's bad news for the poor since it looks like the job market will be inhospitable for years.

Although the pace of layoffs appears to be subsiding and the overall economy is showing hints of stabilization, most forecasters expect unemployment to continue to increase in coming months and to recede only gradually as recovery takes hold. In this Economic Letter, we evaluate this projection using data on three labor market indicators: worker flows into and out of unemployment; involuntary part-time employment; and temporary layoffs. We pay particular attention to how these indicators compare with data from previous episodes of recession and recovery. Our analysis generally supports projections that labor market weakness will persist, but our findings offer a basis for even greater pessimism about the outlook for the labor market. Specifically, we suggest that the relatively low level of temporary layoffs and high level of involuntary part-time workers make a jobless recovery similar to the one experienced in 1992 a plausible scenario.... This projection indicates that the level of labor market slack would be higher by the end of 2009 than experienced at any other time in the post-World War II period, implying a longer and slower recovery path for the unemployment rate.....

And this chart captures their gloomy outlook on the job market.

My concern is that poor and low income families will be disproportionately hurt during a jobless recovery. Management willseek out at first highly educated, skilled workers, well aware that they will pick up terrific talent at a low price. But it will take years for the hiring to include less skilled workers, such as high school dropouts.

The sustainability and global climate change debate is shifting from science to political economy. I'm probably late to this paper, but I just read the keynote address by Yale economist William Nordhaus at the Climate Change conference in Copenhagen, Demark, March 10-12. In Economic Issues in a Designing a Global Agreement on Global Warming, Nordhaus calls for an international carbon tax. His argument for the tax is compelling, as are his concerns over a cap-and-trade system.

Climate change involves a tale of two cultures. The natural sciences are doing an admirable job of describing the geophysical aspects of climate change. The science behind global warming is well established. While the exact trajectory of climate change is imprecisely known because of cascading uncertainties from economic activity through emissions, the carbon cycle, and earth-ocean systems, economic analysis should take the scientific findings as inputs.

But designing an effective political and economic strategy to control climate change will require the second culture - the social sciences - to analyze how to harness our economic and political systems to achieve our climate goals effectively and at low cost. This second task involves a very different set of issues from the natural-science questions. It requires examining questions such as the impacts on the economy and on non-market activities, the costs of slowing or mitigating climate change, the strength and timing of emissions reductions with an eye to the costs and benefits of slowing climate change, the risks of asymmetric and irreversible damages, and the policy instruments for implementing such emissions reductions.

He goes on to say that if economics provides a single bottom line for policy, it's the need to ensure that everyone faces a market price for the use of carbon.

Economic participants--thousands of governments, millions of firms, billions of people, all making trillions of decisions each year--need to face realistic prices for the use of carbon if their decisions about consumption, investment, and innovation are to be appropriate.

He then unpacks the benefits of raising the market price of carbon:

First, it provides signals to consumers about what goods and services produce high carbon emissions and should therefore be used more sparingly. Second, it provides signals to producers about which inputs (such as electricity from coal) use more carbon, and which inputs (such as electricity from wind) use less or none. It thereby induces producers to move to low-carbon technologies. Third, high carbon prices provide market signals and financial incentives to inventors and innovators to develop and introduce low-carbon products and processes which can eventually replace the current generation of carbon-intensive technologies. Finally, and most subtle of all, the use of carbon pricing economizes on the information requirements that market participants need to undertake each of these three tasks. Of course, placing a market price will not work magic. There remain many further externalities and market imperfections in energy and other markets. But without a strong price signal, there is simply no hope for making the vast number of decisions in a remotely efficient manner.

Why doesn't he like cap-and-trade that is a centerpice of the Kyoto model for coping with global warming on an international level?

..It is completely untested in the international context; it has been unable to attain anything close to universal participation; it loses precious fiscal revenues; it leads to volatile prices; and it is an invitation to rent-seeking. It is unlikely that the Kyoto model, even if strengthened, can achieve its climate objectives in an efficient and effective manner.

There is much virtue in simplicity. The case for a "harmonized international carbon tax" for responding to the threat of climate change is strong.

Peter Bernstein passed away on June 5th. He was the nation's leading financial philosopher of risk. Bernstein was one of the wisest people I've ever interviewed over the years, vast in his learning, sound in his judgments, and a delight to talk to. I always lesrned something from him. He was smart and thoughtful.

Bernstin knew the history of intellectual breakthroughs when it comes to the history of risk, the mathematical insights of poet Omar Khayyam and Renaissance scholar Benvenuto Cellini to the quantitative genius of Paul Samuelson and Fisher Black. He was more than a scholar of risk as a history of ideas (and that would be enough of an achievement for almost anyone else.) He also had a ringside seat at some of the most turbulent moments in recent history, growing up during the Great Depression, living through Hitler's rocket attacks on London, remarking on the many financial crisis of the past half-century, from the Great Inflation of the 1970s to the Great Repudiation of the '00s. Along the way he wrote several towering books of finance, including one of my favorite, Against the Gods: The Remarkable Story of Risk.

The word risk derives from an old Italian word, risicare, which means "to dare. "To dare reminds us that the essence of risk is about making decisions or choices with unknown outcomes," Bernstein said. "At its heart, risk management means considering the consequences of each choice we face."

Of course, many more things can happen to you than will happen. "So you manage risks by comparing them to potential returns," he added. "Remember, just because more things can happen than will happen doesn't mean bad things will happen. The outcome may be better than you expect." Or not.

The consulting firm McKinsey has an interview with Brenstein on risk here

I'll miss him.