Warren Buffett on Bank Regulation

Summary

In this transcript, the speaker emphasizes the need for a strong, independent financial regulator to prevent excessive risk-taking by financial institutions. They discuss the challenges of regulation, referencing past failures like Freddie and Fannie, and advocate for a nuanced approach that considers different types of leverage. The speaker also calls for accountability, suggesting penalties for directors and CEOs of institutions that fail, and criticizes the lack of consequences for those who contributed to the financial crisis. They touch on the 'too big to fail' dilemma and the moral hazard it presents, while also reflecting on personal experiences during the crisis.

Takeaways

• 📈 The speaker advocates for a single, powerful regulator to oversee financial institutions, emphasizing the need for someone with authority to prevent excessive risk-taking and leverage.
• 🏦 The speaker discusses the challenges faced by financial institutions in meeting the promise of increasing earnings per share every quarter, which can lead to risky off-balance-sheet activities.
• 📉 The speaker references the failures of Freddie Mac and Fannie Mae, which were heavily regulated but still engaged in risky practices, highlighting the difficulty of effective regulation.
• 💼 The speaker expresses admiration for the Federal Reserve's response during the financial crisis, particularly the actions of Ben Bernanke, and the importance of decisive, swift action.
• 🚫 The speaker argues against setting a fixed leverage ratio, as it doesn't account for the different risk profiles of banks' assets, emphasizing the need for nuanced regulation.
• 💡 The speaker suggests that a smart and strong regulator should understand the complexities of different types of leverage and be willing to speak out about generalized problems in the financial system.
• 🚨 The speaker is in favor of penalties for directors and CEOs of financial institutions that fail, especially those deemed 'too big to fail,' arguing that they should bear significant consequences for their actions.
• 💰 The speaker criticizes the lack of personal financial consequences for leaders of institutions that contributed to the financial crisis, suggesting that they should not have profited from their mistakes.
• 🔒 The speaker supports the idea of 'clawbacks' and restrictions on executive compensation, as well as the prohibition of director's liability insurance, to align incentives with risk management.
• 📉 The speaker reflects on the financial crisis, acknowledging missed opportunities for investment and the difficulty of predicting market movements, even for those deeply involved.

Q & A

What is the speaker's view on having a single big regulator for banks?

The speaker believes in having one strong and independent regulator, like the Federal Reserve, to oversee banks and prevent excessive leverage and risky practices.

Why does the speaker think financial institutions might take on too much leverage?

The speaker suggests that financial institutions, driven by the pressure to increase earnings per share every quarter, might engage in risky practices and leverage without proper oversight.

What role does the speaker think Freddie and Fannie played in the financial crisis?

The speaker implies that Freddie and Fannie, despite being regulated, committed many of the same sins that led to the financial crisis by engaging in off-balance-sheet activities.

How does the speaker feel about the Federal Reserve's response during the financial crisis?

While acknowledging that the Federal Reserve was not perfect, the speaker expresses admiration for their swift actions, particularly under Bernanke's leadership, to stabilize the financial system.

What does the speaker suggest about establishing a specific leverage ratio for banks?

The speaker argues against a one-size-fits-all leverage ratio, emphasizing the need for a nuanced approach that considers the type of assets a bank holds.

Why does the speaker advocate for a smart and strong regulator?

The speaker wants a regulator who understands the complexities of different types of leverage and can effectively communicate and enforce regulations to prevent systemic risks.

What does the speaker propose regarding the accountability of directors and CEOs of large financial institutions?

The speaker suggests that directors and CEOs of institutions 'too big to fail' should face significant penalties, including financial losses, if they fail in their duties and risk the stability of the financial system.

How does the speaker feel about the public's perception of the financial crisis and its aftermath?

The speaker recognizes the public's frustration with the lack of personal consequences for leaders of financial institutions that contributed to the crisis, noting that the public sees no one going to jail or suffering significant losses.

What is the speaker's opinion on the 'too big to fail' doctrine?

The speaker acknowledges the reality of 'too big to fail' institutions and the moral hazard they create, but also emphasizes the need for tougher consequences for those in charge when they fail.

What does the speaker think about the current stance of financial executives on risk management and clawbacks?

The speaker expresses skepticism about the true commitment of financial executives to risk management and clawbacks, suggesting that their current stance might be more about appearances than actual change.

How does the speaker reflect on his own actions during the financial crisis?

The speaker admits that he could have made smarter financial decisions during the crisis, such as waiting to invest in the market, but also recognizes the uncertainty and urgency of the situation at the time.

Outlines

00:00

🏦 The Need for a Strong Financial Regulator

The speaker emphasizes the necessity for a powerful and independent financial regulator to prevent excessive risk-taking by financial institutions. They argue that without oversight, entities may engage in leveraged activities that could destabilize the financial system. The speaker cites the Federal Reserve as an effective regulator, acknowledging its imperfections but also its crucial role in responding to crises. They highlight the importance of a regulator who can act swiftly, like guaranteeing money market funds and ensuring the flow of commercial paper, which Congress could not do with the required speed. The speaker also discusses the complexity of setting leverage ratios, suggesting that a one-size-fits-all approach is not effective, and that a nuanced understanding of different types of leverage is necessary. They advocate for a regulator who can speak out about generalized problems, not just individual institution issues, and who has the courage to address systemic risks.

05:01

💼 Accountability and Consequences for Financial Institutions

The speaker discusses the concept of 'too big to fail' financial institutions and the moral hazard they present. They express frustration with the lack of severe consequences for executives and directors of large financial institutions that contribute to financial crises. The speaker suggests that if these institutions fail and require government intervention, those responsible should face significant penalties, including financial losses and the possibility of criminal charges. They argue for a system where executives and directors are held personally accountable for their actions, with mechanisms like clawbacks and restrictions on director's liability insurance. The speaker also reflects on the government's response to the financial crisis, acknowledging the moral hazard but also recognizing the necessity of government intervention to prevent systemic collapse. They express a desire for a more equitable system where those at the top face consequences proportional to the risks they take.

Keywords

💡Deregulation

Deregulation refers to the reduction or elimination of government regulations in a particular industry. In the context of the video, the speaker is discussing the financial industry and their belief that one strong regulator is needed to prevent financial institutions from taking on excessive risk. The speaker argues against deregulation, citing the need for oversight to prevent financial institutions from engaging in risky behaviors that could destabilize the economy.

💡Leverage

Leverage in finance refers to the use of borrowed money to amplify potential returns. However, it also amplifies potential losses. The speaker mentions that financial institutions may take on too much leverage if left unchecked, which can lead to financial crises. The script discusses the need for regulators to monitor and control leverage to prevent institutions from becoming overextended and causing systemic risk.

💡Off-balance-sheet

Off-balance-sheet activities are financial transactions that do not appear on a company's balance sheet but still have financial implications. The speaker criticizes these activities as a way for financial institutions to hide risk and manipulate earnings per share. The script implies that such practices contributed to the financial crisis and that regulators need to be vigilant against them.

💡Freddie and Fannie

Freddie Mac and Fannie Mae are government-sponsored enterprises that purchase mortgages from banks, which helps to increase the availability of mortgage loans. The speaker mentions them as examples of financial institutions that were regulated but still engaged in risky practices that contributed to the financial crisis. This underscores the complexity of regulation and the potential for failure even with oversight.

💡Federal Reserve

The Federal Reserve, often referred to as the Fed, is the central banking system of the United States. It plays a crucial role in regulating financial institutions and managing monetary policy. The speaker expresses confidence in the Fed's ability to act as a strong regulator, highlighting its independence and the importance of its role in maintaining financial stability, as evidenced by its response to the financial crisis.

💡Commercial paper

Commercial paper is a short-term debt instrument issued by corporations to finance their operations. The speaker mentions the importance of keeping the commercial paper market flowing, which is indicative of the broader need to maintain liquidity in financial markets. During crises, the freezing of such markets can exacerbate financial instability, and the speaker praises the Fed's actions to prevent this.

💡Leverage ratio

A leverage ratio is a measure of a company's financial leverage calculated by dividing its total debt by total equity. The speaker argues against setting a fixed leverage ratio, as it does not account for the different risk profiles of assets. For example, a bank holding only government bonds could safely operate with a higher leverage ratio than one involved in speculative lending. This highlights the need for nuanced regulation that considers the specifics of an institution's activities.

💡Moral hazard

Moral hazard refers to the increased likelihood of a party taking on more risk when they know that the potential negative consequences will be borne by others. The speaker discusses the moral hazard problem in the context of 'too big to fail' institutions, where the knowledge that the government will likely intervene to prevent their collapse can lead these institutions to take excessive risks. The speaker advocates for penalties for directors and CEOs to mitigate this risk.

💡Compensation system

A compensation system refers to the structure of pay and benefits provided to employees, particularly executives. The speaker criticizes compensation systems that do not penalize executives for taking excessive risks, which can lead to financial crises. The speaker suggests that compensation should be structured to align the interests of executives with the long-term stability of the institution and the broader economy.

💡Clawbacks

Clawbacks are provisions that allow an organization to reclaim previously granted bonuses or compensation from executives in the event of financial mismanagement or fraud. The speaker supports the use of clawbacks as a way to hold executives accountable for their decisions and to discourage risky behavior. The script indicates that the speaker believes such measures are necessary to prevent future financial crises.

💡Too big to fail

The term 'too big to fail' refers to the idea that certain financial institutions are so large and interconnected that their failure would have disastrous effects on the economy, thus necessitating government intervention to prevent their collapse. The speaker acknowledges the reality of 'too big to fail' institutions and discusses the challenges this presents for regulation and the need for strong penalties for directors and executives to deter risky behavior.

Highlights

The need for a single, powerful regulator to prevent financial institutions from taking on too much risk.

The importance of a regulator with independence and real muscle to maintain the stability of the financial system.

The Federal Reserve's role as a capable regulator, despite not being perfect during the financial crisis.

The necessity for speed in regulatory responses, as exemplified by the actions taken to save the financial system.

The challenge of establishing a one-size-fits-all leverage ratio for banks due to differing risk profiles.

The idea that a smart and strong regulator should understand the nuances of different types of leverage.

The importance of a regulator who can speak out about generalized problems in the financial system.

The concept that financial institutions that are 'too big to fail' should face severe consequences if they fail.

The argument that directors and CEOs of large financial institutions should be held accountable for their actions.

The view that financial institutions should not allow executives to profit excessively from risky behavior.

The suggestion that there should be a penalty for directors who fail in their oversight responsibilities.

The belief that the financial community should have a sense of responsibility and accountability.

The observation that the public is frustrated by the lack of jail time for leaders who contributed to the financial crisis.

The idea that stockholders in large financial institutions have suffered significant losses, unlike top executives.

The argument for clawbacks and restrictive compensation systems to align executive incentives with long-term stability.

The opinion that directors should not be able to buy liability insurance to shield themselves from the consequences of their decisions.

The reflection on the moral hazard of bailing out large financial institutions and the public's perception of fairness.

The discussion on the potential for smarter financial decisions during the crisis, such as waiting to invest in the market.

Transcripts

and banks do deregulation I need one

regulator one big regulator that was me

I would like it I mean because you need

you need somebody that does have a big

step you know I mean it left to their

own devices people will take on too much

leverage they may not this year next

year hanging but the financial

institutions particularly promising

they're going to increase the earnings

per share every quarter and they'll do

off-balance-sheet things and all of all

of these sins that were committed a few

years ago you know Freddie and Fannie

did a lot of them too and they were

regulated by - and regulated margining

in the office every day so we've had

Congress regulate the two of the five or

six most important financial

institutions United States and it was a

total flop so it's tough being a

regulator and you've it but you want

somebody that is independent somebody

it's got real muscle and hopefully

somebody that you know has an

understanding of what you need to do to

keep the system working oil - and that's

the Federal Reserve I think they're good

at it you know I've had you know they

weren't perfect this time around and

they're now but but Congress wasn't

perfect either

but once the problem came they responded

and you had the untold admiration for

Bernanke if the end have had the

authority yeah and maybe maybe if he

even hadn't thought he had a little more

authority than even did have last fall

there's something to that you know I

mean you had to have somebody that would

step up guarantee money market funds you

know Keaton keep commercial paper

flowing do these things that many people

could have done and certainly Congress

couldn't have done them with the speed

and you know that speed was absolutely

essential I mean you did not have a lot

of time to save this page and they

understood that they and we understand

reacted and gained a lot of power and

and used it there's also this you cannot

establish a particular leverage ratio

can you you don't say that fifteen to

one as far as it should ever be if you

have a bank that owns nothing but

short-term government bonds they can

have fifty to one and they gotta you

know they've got a whole bunch of money

lent out to other guys who are leveraged

in various ways and very speculative

things five to ones too much so pure

numbers don't work so what works that's

the problem that is the problem anyways

I'd be all over what works I mean yeah

it's the problem give me a possible way

of dealing with

I would like to have a very smart strong

regulator that understood the nuances of

different kinds of leverage and and and

what it might mean and and one who would

be willing not only to use those rules

at individual institutions but who would

speak out to the country can speak out

too often an avid meaningful but who

would speak out to the country about a

generalized problem because that's what

we needed it wasn't it wasn't the fact

that it was Bank a or Bank B or Bank see

what was happening was that you were

having a bubble that everybody was

joining in and and speaking out on that

which requires a lot of guts and I may

even get ignored although if it comes

from somebody that is running the Fed

you know or whomever or the front of the

United States I mean there can be people

that will have an impact on that you've

said that you're not in favor of too

much coddling and that you'd like to see

the stick use more absolutely tell us

what you meant well what I mean is that

if you run a financial institution and

it's financial institutions

overwhelmingly they do tend to create

the problems because there's this

aggregate aggregation of capital one if

you run a financial institution that in

effect can bring down the system unless

the federal government steps and you get

at that point I think something very bad

should happen you know I don't think you

should walk away with a lot of money or

even with 10 percent of your previous

net worth or anything absorb and I think

the directors who selected you and let

you operate in that manner should have

some real downside you know I'm not for

shooting them but would be they what do

you can't buy insurance

no I yeah well I would probably have in

terms of the very large financial

institutions that if they if they had to

go to the government you know and the

government had to act because there are

going to always be too big to fail

institutions it drives regulators crazy

but that's the reality and if an

institution comes in and says if we go

down the we're pulling the whole country

down with us I think that the directors

and there's a CEO of an institution like

I think the director says you certainly

have to give back you know this should

five times the highest fee they've

received in the preview because you're

sitting around those places now getting

two to three hundred thousand dollars in

here you know and and for them all I

want for my two hundred the three

hundred thousand dollars a year is

somebody that is selecting and designing

a compensation system for the person

they put in charge the CEO who should be

the chief risk officer I want them to

have a system that penalize --is that

person very very significantly and if

they don't they don't create that kind

of if they pick the wrong person or they

let that person go off the reservation I

want them to pay also alright so let me

just son you you you want there to be a

penalty for directors who do not do

their job that what any but you

recognize that there are gonna be

financial institutions that are too big

to fail it has been and will continue to

be to be you can't simply say we're

gonna let anybody fail no matter how big

no matter what the consequence are not

just gonna have a mom-and-pop bank on

every corner and do you think that the

financial community has any sense of of

I'm sorry well most of them to do it I

mean in the sense that if you take the

leaders of these institutions that got

him in a lot of them are gone now

they're gone with more money than I

would like have them gone with and I

think what's infuriating to the American

public if you take the people in Omaha

you know exams they have seen lots of

unemployment they've seen you know many

cases their their homes or their friends

homes foreclosed they seen all this

these things happen to them and you know

nobody's gone to jail and as far as

they're concerned the leaders of

institution a B or C that that have in a

big way contributed to these problems

you know ten million instead of 100

million or something like that but they

don't say anybody want to jail they

don't see anybody they don't see anybody

being held a very responsible and they

don't believe that if they were in the

same place a much lower investment that

anybody would have come along and taken

care of them well yeah and and they're

right about that I mean if I if I have a

tiny little business it fails it doesn't

affect the United States but if you have

Freddie manic a macron Fannie Mae and or

AIG or

yeah they and they they would have

affected I mean we could not stand those

dominoes

and it drives people crazy that we

couldn't but we couldn't I mean if those

a few more Domino's had fallen if that

weekend of September 12th the 14th or

whatever it was it if one more Domino

that you know Merrill Lynch going Morgan

Stanley would have been next the

dominoes were so lined up and they're so

big that it without the government they

would have gone down they would've gone

up but bear this in mind they talk about

moral hazard on this there's a moral

hazard if you look at City 90% of the

market values disappeared if you look at

Freddie Mac 90% of the market value the

common more than that's may a IG all of

them so the stockholders have gotten

totally creamed the owners have gotten

totally creamed so it's not like anybody

it was a sonic holder of City or Freddie

or Fannie or AIG or you name it is

thinking ha ha you know the system's

gonna save me because it didn't save it

they got killed but the guys at the top

did not get ya in most cases did not get

killed and they're the ones that made

the mistake should they have gotten

killed so they should have been harder

so how would the government have done

that I would probably have something

with those kind of institutions where no

one got rich from running an institution

like that until about five years after

they left I mean yeah and I have had a

very restrictive and I have clawbacks

and I'd be plenty tough and I'd be tough

on the directors if they hadn't put in

those none of our and they say that now

if you listened to the executives today

they say we're in favor claw backs and

we've we've instituted those kinds of

things I don't know whether they have

well they they've done some but I

probably squirt

against this sort of risk I wouldn't let

him buy director's office and insurance

liability insurance we don't have that

at Berkshire you know I mean if our

shareholders are gonna go down I want me

to go down with them and the directors

to get out with them I've you know we've

taken on the job and and and you know if

the ship goes down we shouldn't we

should not get the first line when you

look at that year this is a bookbinder

all sort of area you're in their moments

for you I mean you were at the other end

of phone calls from people who who

watered money

and in some cases advice but definitely

money so the most unwanted money you

know are there moment you look back and

what you said know that you might have

said yes I mean do you have any sense of

you just call you I know I mean it's

just like saying you're at the plane

that comes here you gotta have a

second to decide whether to swing yeah

you know no I know you're not a man to

agonize but I mean have you mean oh I

could have done way smarter things yeah

no no I wait Mike

I did not optimize the period could you

had money and they needed money and they

would have given up a lot for that money

yeah plus the bottom of the market was

six months later I mean it was

significantly lower so if I just saved

the money just put in the market six

months later I'd have done way better

than making these deals right but I

didn't know that at the time so you said

I'm optimistic but I'm not sure my

optimism is justified well I