In the midst of the worst financial crisis in the world leader of capital market, a debate is going on as to whether the solution should include more regulation of the capital markets or less. Those who argue that there should not be more regulation cited the negative effects of the Sarbanes-Oxley Act enacted in 2002 in the aftermath of the Enron scandal as a reason for opposing more regulation.
In my view, the evidence of this current crisis speaks clearly for itself. The more regulated commercial banks were allowed to trade heavily in unregulated financial products, while the lightly regulated investment banks were allowed to trade freely with the commercial banks. Even though the commercial banks were more regulated, because of their heavy dealings with the investment banks, the end result was both needed to be rescued. Of course, lax supervision, which is a problem with execution rather than legislation, allowed banks to lower lending standards. Regulators were at fault in believing that just because banks claim that they would immediately pass on most of the risks of the dicey mortgages to a third party by selling mortgage backed securities to pension funds and other non-bank financial institutions, banks should be allowed to lower their lending standards. More regulations, specifically in respect of trading of derivatives and the intertwining of business dealings with non-bank institutions, should be required, as well as better implementation of existing regulations.
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I was wrong. There was less regulation on the banking industry's lending practice than I thought. Read this excellent article in Business Week : http://biz.yahoo.com/bizwk/081010/0842b4104036827981.html
The US federal government and Congress had been relaxing lending requirements and regulation of banks' mortgage lending standards since 2003. This populist approach that pleased mortgage brokers, bankers and speculative general public is now to haunt everyone.
Statements from Buffett about OFHEO, the regulator of Fannie and Freddie: 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.
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. Or even when the management doesn't know what's
going on, and--just take Bear Stearns. Bear Stearns had--I read it, anyway--750,000 derivative contracts. Now, you know, I could clone Albert Einstein, you know, and--many, many times and have him work 12-hour days for me and he would not be able to keep track of what's going on in an institution
like that. It's--the ones that are too big to fail may be too big to manage, in some cases. And they're particularly difficult to manage if they're promising Wall Street and their investors that they're going to do things that can't be done.
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