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Charlie you've often complained that accountants are the root of much
evil and folly. As we look at the current situation in our financial markets,
how much of the responsibility would you lay at the feet of the accounting
profession?
Well here I am, a voice in the wilderness.
But I would argue that a majority of the horrors we faced
would not have happened if the accounting profession were organized properly. In
other words, they have a position from which if they behaved intelligently and
correctly, they could prevent a huge amount of all what's wrong with the system;
and they fail utterly— time after time, after time.
They are way too liberal in providing the kind of accounting
that the financial promoters want.
So, in other words, they've sold out.
They do not even realize that they've sold out, which of
course is a common human psychological phenomenon, squelched by denial. So what?
Exactly
Whether you recognize this and if such an action would make
you think poorly of yourself— or if it would interfere with your income and so
on— it is on a subconscious level— without any malevolence.
The accounting profession is behaving in a way that makes
Sewers look well compared to what could reasonably be done with intelligence
and honor.
The accounting profession is a sewer.
It would you give an example could you give an example of a particular
accounting principle or practice?
Take derivative trading with mark-to-market accounting which
degenerates into mark to model— two firms make a big derivative trade— both
sides show a large profit on the same trade, and they can't both be right.
It can't both be right and both of them are following the rules to the
tee…
Yes and nobody's even bothered by the fact that that's
happening, right?
It violates the most elemental principles of common sense
and the reason. They do it, there's a demand for it from the financial
promoters.
I remember when interest rate swap accounting was done on a
different and more conservative basis and the Morgan bank was the last holdout.
And finally, they couldn't hold their trader’s report— the same kind of income
other people reported was higher…
And so they threw out the sound accounting and went to the phony
accounting.
They way did it was kind of funny at the time, which was
many decades ago and so some of the people were kind of reluctant, but they
said we just have to go with the flow.
It was a huge mistake.
Is this a problem that can be
fixed with the accounting profession with the accounting process or something
that well?
Oh I think you're talking about a problem rooted so deeply
in human nature that I don't think you'll live long enough to see it gets 20
percent fixed in the direction it should go in your remaining lifetime you'll
be a fortunate man.
So how do we get there? So let's assume that we would actually want to
accomplish something?
I don't know how to transform all human life in the world
we're just talking about the NLA surely
Well, but accounting is a big subject and they're huge
forces in play and the entire momentum of existing thinking and customs is in a
direction which allows these terrible follies to happen.
And the terrible follies have terrible consequences but
we're in now is and it's triggering circumstances.
It's worse the Great Depression?
No. We're not the economy hasn't contracted as much as the
Great Depression, but the malfeasance and silliness it was the triggering—the
event was way greater. So, sure, it was more widespread in the 20s— a tiny
little class of people were our financial promoters and a tiny little class of
people were the people that bought securities this now is deep in the whole
culture and it was way more extreme.
So, if sin and folly get punished we're in for a hell of a
punishment.
So it's a more pervasive problem and it's also a more global problem?
Yes
And do you see a chance that it does reach to a level a closer to the
Great Depression? How bad does this get, Charlie?
Well, nobody knows that because we've never done this before
and it's we have a bigger credit bubble we have worse follies more
interconnected global system. If we responded to this one the way people
responded to the 30s, in my judgment, it would be way worse and we would have a
catastrophe which you can argue gave us Hitler and World War II.
A lot of things that we didn't need.
I mean it was not getting your financial integrity and the
integrity of your accounting right. It has enormous implications for the future
of mankind and yet very few people realize how much we screwed up.
Very few people realize even in leading law school and tools
and business schools how Enron never could have happened if they hadn't changed
the accounting rules. And what we have now is just a bigger widespread and Enron.
You know I like I like telling my students that no civilization is
greater than its plumbing and accounting is really the plumbing of the
financial system and to the extent that the plumbing can't serve the function,
the whole the whole edifice, really, in many situations is not going to work the
way that it's intended.
Idiot bubbles blessed by accountants are terrible for the
whole civilization.
It would be much better if we didn't have these idiot
bubbles or at least if they were dampened very considerably.
But people use the
idiom "nobody wants to take the punch bowl away when everybody's having a good
time at the party."
But that's the accountant’s job and that's the central banker’s job.
And you're never popular we don't have a business's job and
the people who do it tend to be despised and hated and a lot of people are
willing to be despised and hated and ruin their fellow-creatures parties etc.
The main thing you have to realize is Ben Franklin's basic
idea that an ounce of prevention is worth a pound of cure; that's understated, an
ounce of prevention is sometimes worth a ton of cure.
And your only real chance was not to allow it to happen when
the regulators put in the options exchanges there was like one letter saying you
shouldn't do this and Warren Buffett wrote it.
he just said “this is not doing any good for the wider civilization
we don't need this” you know he was all alone and he was totally right when we
separated banking from Investment Banking on the theory that investment banking
had a natural proclivity to get a fair amount of knavery and folly into it and
that we wanted to protect our banks from the contagion that was a good idea
when we created margin rules that discouraged heavy borrowing against securities—
Just to make more money when the securities went up in value that was a good
idea.
When they wanted to make the market system a better gambling
casino, as a side function of unnecessary capital market with vast profits for
the people who were helpers (croupiers) in the trade the market makers and the brokers and
so on, that created a big constituency in favor of a dumb change.
And there was little Warren Buffett, saying this is a dumb
idea, we're not controlling margins, if you're having option exchanges and get
unlimited leverage whatever the more leverage that will automatically with an option
exchange of course and then they do.
Our regulators allowed the proprietary trading departments at investment banks to become hedge funds in disguise, using the 'repo' system—one of the most extreme credit-granting systems ever devised. The amount of leverage was utterly awesome.
Our regulators allowed the proprietary trading departments at investment banks to become hedge funds in disguise, using the 'repo' system—one of the most extreme credit-granting systems ever devised. The amount of leverage was utterly awesome.
The derivative trading which made the options exchange look like a
benign.
Well, yet and so just one after another we made these insane
departures from the corrective devices. We put in the last time we had a big
trouble and that really worked quite well— the investment banks of York and the
Melons were running First Boston and Morgan Stanley was a very conservative
place chastened by the 30’s investment banks were partnerships they were
totally private the partners were dependent for their retirement on the
prosperity of the firm's they left behind and the customs and culture they left
behind.
And the places were much more responsible and honorable. The
old First Boston Company had as one of its early employees –one of its
employees a good friend of mine—and when he went there in the early 50's, they
cared terribly about the consequences to their clients’ long term prosperity from
the securities they sold.
That ethos by the time the year 2006 came along had pretty
well disappeared.
Now you and your partner Warren Buffett have four years complained and
warned about the dangers that you perceive in the modern derivatives markets in
particular credit derivatives yeah it'll also conserve all so concerns about
you know interest rate swaps currency swaps equity swaps but your real concern
has been about the credit derivative market
Well the interest rate swap had enormous dangers in it—
given the size it was on at and the accounting that was allowed but, the credit
default derivatives just went to new levels of excess from something that was already gross
and wrong. What happened there was rather interesting in the 20’s we had the bucket
shop right?
In the '20s we had the 'bucket shop.' And the "bucket shop" was a term of derision because these people
ran a gambling parlor they didn't buy any securities. It just enabled people
to make bets against the house and the house furnished little statements of how
the bits went out. It was like the off-track betting system.
Until the house lost its money and all the sudden disappeared
Yes
Or the house made its money and all of a sudden disappeared
Yes
Either way, but the bucket shop was regarded in retrospect
at the end of the 20’s as a criminal enterprise— counterproductive to the
nation.
Derivatives trading with no central clearing brought back
the bucket job.
But tell me
Because you could make bets without having any interest in
the basic security and so and people did in billions and billions and billions
of dollars.
So we had a system in the professions and in the regulatory
agent that were empty.
Some of the most eminent and most admired people in finance
including Alan Greenspan argued that derivatives trading in the form of the old
bucket shop was a great contribution to modern economic civilization and now
the Federal Reserve…
There’s one word for this, and it's “insane”.
The problem that you're talking about now, Charlie, is really much
bigger than just GNAC or will the government step in at General Electric have a
look at the balance sheet of the Federal Reserve.
It has ballooned.
The Federal Reserve is today buying assets and I think they're probably
doing what's absolutely necessary in order to keep liquidity flowing in the
short term but they're buying assets today that they wouldn't even have
considered looking at a year ago.
There are over 800 billion dollars of this stuff sitting in the Federal
Reserve balance sheet right now and that number in my view is much more likely
to double or to approach two trillion dollars within the next 18 months than
any other number that you're likely to see
Well, I think the problem is so extreme that nothing un-extreme
will solve it.
The people in the government that are doing these extreme
things I'm sure they're making a lot of decisions that retrospect will be seen
as mistakes. But given the human condition where they have to do extreme things
under fire, I am not inclined to criticize.
I like the fact that they are so willing to do things that
have never been done before.
Because we have problems right we have never seen before.
I like the fact here I am a right-wing Republican, I like the
fact that Obama has put into the White House, Larry Summers was a ferociously
smart human being, and will try and do the right thing even if there is a lot
of defensive people. I think that's a quality that we need right now.
Well you know you mentioned a
president-elect Obama. Soon to be President Obama.
What do you think of the job that he's doing so far the transition team
that he's put together directions that he's pointed that he's going to try to
take the economy in?
Well, I would argue
that given the circumstances, and given the background he comes from, I would argue
that he is doing very well indeed
Going back to your observation
where you were supporting what the Federal Reserve is doing in terms of buying
up all these assets while ago
I have a comment on
every individual decision but sure, extreme aggression and trying to rent the
total collapse of the system feeding out itself, I think, is totally correct.
I think that both Bernanke and Summers are likely to understand
that way better than most people would.
We're very lucky to have both of them there.
Geithner I don't know. But I have no feeling that he isn't a
good member of the of the threesome.
As people look at the situation that's currently evolving many people
sort of see two problems in the short term there's a concern about deflation we
have a massive contraction of credit formation there's deleveraging that's
going on at a pace that nobody's ever experienced before.
Unemployment is going to rise
very significantly— the destruction of wealth on the private balance sheets
unprecedented, consumers are going to be spending less, they're going to be
trying to rebuild their own balance sheet, and clearly this is a situation
where the government has got to come in strong and the government has got to
come in heavy.
Do you have any views on the fiscal side of things the government's
talking now— about an eight hundred and fifty a billion dollar package the mix
of fiscal stimulus tax cuts and the like?
Not only do we have to save the financial system in spite of
our revulsion about the way many of its denizens behaved, but we also need a
huge a huge spending stimulus from the federal government.
I don't regard that as all bad at all, I think there's a lot
to be done in this country.
I think we need a whole electricity distribution system
which is more efficient and bigger and more flexible and more perfect than we
have and I think that this is an opportunity to get that done.
I think much could be done in medical care and I think the
hospitals of the country are probably about to get a vast improvement in their
facilities and I think that's all too good.
we have a whole lot of things that are worth doing Obama is not
talking about scooping of people and having them stand around holding shovels
in the middle of some forest.
I mean he is talking
about fixing infrastructure and, so on, the city of Los Angeles where I live
the streets are disgraced compared to the streets of Japan. Japan had so much fiscal
stimulus you can't find a pothole on the side of a mountain in Japan.
But you can find but you can find lots of airports that nobody uses out
in the rural Japan.
That may be but at least they fixed all the streets and the trains
and everything else so I welcome a fiscal stimulus.
that will now improve a lot of
things but as part of the government's response the government the United
States and governments worldwide are printing money de-facto at a rate that is
absolutely unprecedented and if you know we know traditionally that if you
increase the supply of something its price is going to go down. Short-term
everybody's really too worried about deflation.
We would have been much better if we hadn't worked ourselves
into this position where we have to do this and you are right to point out that
there are dangers from what we have to do but the dangers from what we have to
do are less than the dangers that would plainly come if we responded as we did
to the 30’s.
In an ideal world of classical economics, you can say just, what
everybody suffer and then whether we're back itself from a low level we can't
do that with a modern voting democracy.
We're hooked for exactly what is happening and so are the
other advanced nations and sure there are dangers and we may get some inflation
but what the kind of economic misery that gave us the rise of Adolf Hitler. That
we don't want. And we should skirt that danger, cheerfully accepting the dangers
that come from us going.
So you see the situation as being one were trying to manage
the lesser men of two evils. Or the least of many evils as a practical matter.
And you know what I'm hearing from you Charlie is that so far so good
it appears that the government is on a reasonable track
It is very reasonable to react with the extreme bigger
that's been shown in fact I would argue and retrospective the vigor wasn't
quite enough I would agree with you and I would argue that it was pluperfect
obvious they had to save all these banks and the major and investment banks
So scale of one to ten how big a mistake was it that?
They let Lehman go.
I don't think that
was a mistake.
Interesting
I think it actually helps to have one or two go.
I think you need some examples and a big mess and just save
everybody right no matter how awful.
We were that would have created just unlimited revulsion in
the body politic.
So, I think the people had to decide that some people were
going to be saved and some people weren't.
I think it was correct that they decided they have two
categories through the saved and the unsaved and I'm not going to quarrel with
their decisions. It is interesting. I probably would let a bloody lemon go too.
Interesting, even though the markets seized up very dramatically afterwards
and we had some of the most difficult short-term financial consequences of that
failure.
Well, we needed a total correction mm-hmm the system look
was evil and stupid we didn't need all our bright engineers going into the
derivative trading and hedge funds and so on and so. we have the civilization
totally out of control.
Are they not going there in the
future?
And we were not going to get out of that without a lot of
mess and contraction and the mess and contraction was going to cause some
operations to perish I knew Arthur Andersen partners who were honest decent
people and who suffered terribly.
Any situation in others the problem
of moral hazard yes so large
You really can't have the rule no matter how awful you are
you're always going to be safe
Simply because you're big enough and you're connected enough you have
to allow for failure
You have to have allow for failure
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