Far be it from me to start a tiff with Warren Buffett, but watch out, because it's on -- sort of. Via Marginal Revolution, some folks are using this excerpt from an interview from the Berkshire Hathaway magnate as an argument against regulation:
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's the thing: There is a difference between regulatory oversight and regulations themselves. Buffett certainly knows more than most about the propensity of financial institutions to deceive people, but the problem here wasn't that Fannie Mae or Freddie Mac really deceived their regulators. The problem was that the regulations that would prevent the current financial crisis were not in place. Incidentally, no matter how many times people repeat the lie, Fannie Mae and Freddie Mac did not cause the financial crisis, their collapse was a result of it. They didn't own many sub-prime loans until Congress and the Bush administration urged the institutions to purchase them in late 2007/early 2008 in reaction to the collapse of the housing bubble. Last year, the two only had about a third of the Mortgage Backed Securities market share, and a smaller percentage than that of "toxic" mortgages. But this is the key thing: There were no rules against doing these things.
What kind of regulations would have helped? Well, for one, the SEC shouldn't have allowed investment banks that collapsed, as well as hedge funds, to maintain debt-to-capital rations of 30 or 40 to 1 (most banks are around 10 to 1).This fact in itself helps explain why the pop of the housing bubble has such deep ramifications across the economy. As well, bond rating firms should have been policed to avoid conflicts of interests, so that toxic CDOs weren't rated at the highest value, AAA. Predatory sub-prime loans that presumed huge increases in home equity shouldn't have been allowed, and No-Income/No-Asset loans should have been scrutinized much more than they were.
Of course, Buffet is right that we need to do a better job of policing financial firms. But that's no reason to assume we don't need to put the right rules in place to ensure that companies don't have incentives to risk much more than they can afford, and then ask the government to bail them out.
-- Tim Fernholz
