Tuesday, August 23, 2011

Buffett on Bank Reform: "Too Big To Fail Will Always Exist"

An excerpt from a recent Buffett interview with Charlie Rose. In this part of the interview, Charlie Rose asks Warren Buffett if he thinks Dodd-Frank was the appropriate reform for the financial system.

BUFFETT: I think there's two things that are needed to keep the financial system from going crazy. One is keeping some limits on leverage and we didn't do a very job of that last time. And incidentally...The second thing is having the proper incentives for people at the top of important financial institutions. We saw institution after institution go to the government and say we're too important to this society that you can't let us fail. So pour in the money, do whatever's necessary and I'm going go off and be rich. I'm the guy that screwed it up. I think you've got to have down side, really drastic down side for the people that run financial institutions, big ones that get into trouble. And we need those incentives and I don't think they've attacked that yet. That can be done through the board of directors.
ROSE: Too big to fail continues to exist.
BUFFETT: Too big to fail will always exist. There will always be institutions that are too big to fail. They're deciding over in Europe that Greece is too big to fail.
ROSE: Ok. But could they be broken up. I know that. Should those institutions be broken up?
BUFFETT: No, we decided the whole banking system was too big to fail when we put in the FDIC in effect. We can't exist without them. So we have to do something to change the behavior of people that are at the top of those institutions so they have huge downsides. They didn't have down side. I'm not going to name names but those people did not have down side. They had down side to their reputation but they walked away with tens of millions of dollars so you can't that have that situation exist and expect great behavior. And then you have to have some restrictions on leverage.
ROSE: But has that changed?
BUFFETT: The incentives have not changed very much. They say they've changed by paying them more stock and all that. But that isn't draconian enough for me. 

It seems like the financial-reform law that is Dodd-Frank, a 2000 plus page document, creates plenty of regulatory uncertainty (many new rules remain in flux) yet does little to address the most crucial systemic problems.

"There are 400 rules being made now, and there are things in there that are downright idiotic," - Jamie Dimon speaking before the Council of Institutional Investors

Dimon recently called the law "Dodd-Frankenstein".

It's not exactly surprising he'd criticize the law but Dimon's often pretty good about calling things as he sees them.

Reduce leverage, increase transparency on derivatives (expose hidden leverage and risk), and separate the speculative activities of "casino" banking from "utility" banking.

Previous post: The Banking Power Utility

Most importantly, as Buffett says above, make sure those running these institutions lose much more than their reputation when a financial institution is put on the brink of failure.

There is far less leverage in the banking system. That's certainly a good thing. Otherwise, it seems by all accounts that Dodd-Frank created plenty of unneeded uncertainty yet does little when it comes to solving the tough problems. We've essentially gone the route of not reforming what needs to be reformed the most while creating uncertainty.

No doubt this contributes to a less healthy credit creation and investment that's needed so badly right now in the economy. Check out the full interview.

Adam

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