Regulation, a dialogue with Warren Buffett

by on October 5, 2008 at 5:46 am in Law | Permalink

Via Craig Newmark:

QUICK: If you imagine where things will go with Fannie and Freddie, and
you think about the regulators, where were the regulators for what was
happening, and can something like this be prevented from happening
again?

Mr. BUFFETT: Well, it’s really an incredible case study in regulation
because
something called OFHEO was set up in 1992 by Congress, and the sole job
of OFHEO was to watch over Fannie and Freddie, someone to watch over
them. And they were there to evaluate the soundness and the accounting
and all of that. Two companies were all they had to regulate. OFHEO has
over 200 employees now. They have a budget now that’s $65 million a
year, and all they have to do is look at two companies. I mean, you
know, I look at more than two companies.

QUICK: Mm-hmm.

Mr.
BUFFETT: And they sat there, made reports to the Congress, you can get
them on the Internet, every year. And, in fact, they reported to
Sarbanes and Oxley every year. And they went–wrote 100 page reports,
and they said, ‘We’ve looked at these people and their standards are
fine and their directors are fine and everything was fine.’ And then
all of a sudden you had two of the greatest accounting misstatements in
history. You had all kinds of management malfeasance, and it all came
out. And, of course, the classic thing was that after it all came out,
OFHEO wrote a 350–340 page report examining what went wrong, and they
blamed the management, they blamed the directors, they blamed the audit
committee. They didn’t have a word in there about themselves, and
they’re the ones that 200 people were going to work every day with just
two companies to think about. It just shows the problems of regulation.

QUICK: That sounds like an argument against regulation, though. Is that what you’re saying?

Mr.
BUFFETT: It’s an argument explaining–it’s an argument that managing
complex financial institutions where the management wants to deceive
you can be very, very difficult.

Here is a good article on what the mortgage agencies have been up to.

Dainius Blynas October 5, 2008 at 8:43 am

that reminds me of 1984 book by Perrow “normal accidents” where he argued that you cannot make nuclear energy save, because the stuff is simply too complex.

In the same vein Zizek in interview recently said this idea of more regulation is a way of not thinking if this financial mess could be normal functioning of the system (freely paraphrased by me).

Anonymous October 5, 2008 at 9:48 am

“More regulation” is a variation on “Hope springs eternal.”

meter October 5, 2008 at 10:23 am

So in the end Buffett has no answers either.

Affe October 5, 2008 at 11:09 am

So, if these things are by definition too complex to regulate, does the current bailout then essentially encourage complexity and risk taking ?

sort_of_knowledgable October 5, 2008 at 11:37 am

The human body is complex and probably not more understood than the financial markets. Does that mean that doctors should not try to treat patients?

Andrew October 5, 2008 at 11:48 am

“Does that mean that doctors should not try to treat patients?”

When they are going to make it worse, yes, that’s what it means. In fact, there’s an old saying that doctors used to say regarding this phenomena.

meter October 5, 2008 at 12:05 pm

Andrew prefers the “on a wing and a prayer” school of governance.

Does that mean that doctors should not try to treat patients?”

When they are going to make it worse, yes, that’s what it means.”

Your after-the-fact opinion of ‘make it worse’ is no more an answer than current regulation schemes.

Gary Sugar October 5, 2008 at 1:57 pm

Regulators should be paid for the violations they catch and penalized for the violations they don’t catch.

Voltaire in '08 October 5, 2008 at 7:50 pm

Tyler, the only problem with Buffett’s comments on OFHEO is that OFHEO seems to have been the result of a Congressional debate between Jim Leach (R-Iowa) and Barney Frank (D-Mass) in 1992 over whether to have a strong or weak regulator over Fan and Fred. Frank won, of course. The point is that it was precisely the purpose of OFHEO to provide weak oversight, so that the politicization of the mortgage market that Frank and friends aimed to achieve could proceed unabated. Wapo reported on all this not too long ago.

eRobin October 5, 2008 at 8:53 pm

I must have goofed up the html. Here’s the quote from Tanta:

I think we can give Fannie and Freddie their due share of responsibility for the mess we’re in, while acknowledging that they were nowhere near the biggest culprits in the recent credit bubble. They may finance most of the home loans in America, but most of the home loans in America aren’t the problem; the problem is that very substantial slice of home loans that went outside the Fannie and Freddie box. But Krugman is right to focus on the fact that it was the regulatory and charter constraints of the GSEs that kept that box closed. In the schizoid reality of the GSEs, when they had their “shareholder-owned private company” hats on they did plenty of envelope-pushing. When they had their “affordable housing” hats on, they rationalized dubious theories of credit quality–like the fervent belief that low or no down payment can be fully offset by a pretty FICO score–to beef up their affordable housing goals, often at the expense not of the poor put-upon “private sector” but of FHA, whose traditional borrower pool they pretty thoroughly cherry-picked. Nonetheless, the immovable objects of the conforming loan limits and the charter limitation of taking only loans with a maximum LTV of 80% unless a well-capitalized mortgage insurer took the first loss position, plus all their other regulatory strictures, managed fairly well against the irresistible force of “innovation.” If there has ever been an argument for serious regulation of the mortgage markets, the GSEs are it.

at this url: http://calculatedrisk.blogspot.com/2008/07/krugman-on-gses.html

Andrew October 6, 2008 at 6:28 am

“Your after-the-fact opinion of ‘make it worse’ is no more an answer than current regulation schemes.”

Huh? What’s the question again? So, regulation is a brand new idea. This is the first time someone has said “Eureka! They shall be regulated!” After the fact regulation is exactly like treating the last disease.

“Andrew prefers the “on a wing and a prayer” school of governance.”

Nope. I just think all the people claiming we have an unbridled banking and mortgage orgy and all this would have been prevented had the benevolent regulators been in charge are clowns. They show up after the main show and stumble out of their clown car honging their horns and pulling their noses.

Most of what Buffett says about governance in general I would like to see happen. I’d like to see stronger shareholder activism. Maybe that will come if enough of them get wiped out by the government. Which brings me to another silly statement the statists keep parroting, that the people who caused this are getting away unscathed.

In the end, regulation has to come from inside the system. Come on. Do people really believe that some government desk jockey is going to see these things coming before the people who got creamed by them do? Seriously? A government regulator does the same thing as a regulator on an engine. It just slows it down, it can’t make right choices. So, that’s your choice. If you want to slow things down, fine for you, but you don’t get to choose the magical best of all worlds.

Slocum October 6, 2008 at 7:35 am

How about this: regulate, but when it becomes apparent that the entities being regulated are gaming the system*, change the regulation scheme.

But ‘gaming the system’ involves amassing political power and connections sufficient to prevent government from ‘changing the regulation scheme’.

Many people did know that Freddie and Fannie were in trouble, and there were serious efforts to ‘change the regulation scheme’, but Freddie and Fannie’s political allies prevented it.

eccdogg October 6, 2008 at 10:20 am

“The human body is complex and probably not more understood than the financial markets. Does that mean that doctors should not try to treat patients?”

The difference in complexity is stability.

In the finacial markets intelligent beings are actively trying to circumvent your regulations. The only corrolary to medicine would be a rapidly mutating disease that changes form with each treatment and moves from organ to organ.

That is what makes regulating finacial markets so hard.

meter October 6, 2008 at 11:32 am

“Most of what Buffett says about governance in general I would like to see happen. I’d like to see stronger shareholder activism. Maybe that will come if enough of them get wiped out by the government. Which brings me to another silly statement the statists keep parroting, that the people who caused this are getting away unscathed.”

The people who caused this *are* getting away unscathed. CEOs are dotting the skies in their golden parachutes (take a look at what WaMu’s CEO will receive for only a few weeks on the job). Banks will be bailed out. Lendees will be saved.

You think otherwise?

meter October 6, 2008 at 1:35 pm

Yes, but the people in charge have already skated off with massive payouts.

Anyone defending these obscene amounts of money being paid to the incompetent is morally bankrupt and not to be trusted.

flash games May 10, 2009 at 1:45 am

To be more specific, there are only a few hundred countries, and some of them don’t have financial markets, it’s basically impossible to get many of them to agree to experiments, and double-blind experiments on financial market regulation are impossible.

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