Munger and the Concept of Febezzle

In Charlie Munger’s November 2000 speech at the Philanthropy Roundtable, he introduces a concept called "febezzle," a term he created from the word embezzle. In a nutshell, it is a situation where bull markets and rising stock prices create the illusion of wealth, even though no new value has been created. Money is moving around, but nothing new is being generated. Here is an explanation of what febezzle really means, why bull markets can disguise waste and why these illusions eventually disappear.

Embezzle, bezzle and febezzle

Before explaining febezzle, it helps to understand where Munger got the idea.

• From embezzlement to bezzle: Munger borrows the original concept of “bezzle” from economist John Kenneth Galbraith. Galbraith coined the word as a shortened form of embezzle to describe the economic effect of undiscovered embezzlement. Here’s a simple example. An employee secretly steals $100,000 from a company. The employee now has an additional $100,000 to spend, while the company doesn't yet realise that it has lost $100,000. The employee feels richer, but the company doesn't yet feel poorer. So for a period of time, it appears as though there is more wealth in the economy than there actually is. The eventual discovery of the theft removes that illusion. Munger takes this idea a step further with febezzle.
• Febezzle: Munger put forth the question: are there any legitimate activities that can mimic an effect similar to undiscovered embezzlement, ie, creating the appearance of an increase in wealth without a corresponding real increase in underlying economic value? His answer is febezzle. One of his examples is investment management. Suppose a foundation spends 3% of its assets every year on unnecessary investment costs while its stock portfolio is rising rapidly. The foundation continues to feel richer because the value of its investments is increasing. At the same time, the people receiving those fees feel that they are legitimately earning income. While money has changed hands, the economy hasn't necessarily become 3% richer as a result. As Munger puts it, the situation can function like undisclosed embezzlement — except that, unlike actual theft, it isn't necessarily discovered quickly, because nothing is lost. But, nothing is gained, either. As long as asset prices keep rising, the process can continue.

A bull market can sustain the illusion of wealth for a surprisingly long time. But asset prices don't rise forever. When markets eventually correct or decline, the wealth effect works backwards. An investment manager who appeared brilliant during a rising market may not look as impressive anymore! And costs that seemed insignificant when returns were high are questioned and feel much more expensive when returns are weak.

The enduring lesson…

Munger's concept of febezzle is ultimately a warning about why we shouldn’t confuse rising prices with genuine wealth creation. A rising stock market can make investors, companies and even the broader economy feel richer. But rising prices alone don’t tell us how much underlying value has actually been created. And, a bull market can conceal the costs of inefficient investment, excessive fees, speculative behaviour and poor capital allocation.

That doesn't mean every bull market is an illusion, or that rising stock prices don't reflect genuine wealth creation. Munger's point is more nuanced: some apparent wealth can be sustained by rising asset prices and financial activity without creating equivalent underlying value.

For investors, the lesson is to look beyond the headline returns and ask what is actually creating the wealth, how much of it is being consumed by costs, and whether the assumptions supporting today's valuations are likely to hold.