A Failure Of Regulation

Many folks these days are blaming our current financial woes on a lack of regulation. They seem to think that an abstract term like “regulation” somehow gives government amazing powers to ensure that bad things won’t happen. Which is why this interview with Warren Buffett (c/o Coyote Blog) is telling:

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.

There are all sorts of problems with regulation, such as the Bootlegger-Baptist phenomenon, regulatory capture, and all the corruption and back-scratching associated with lobbying and rent-seeking.

It just shows that despite 200 employees put in place to oversee only two companies, they still couldn’t overcome the institutional incentives against rocking the boat. As Stephen pointed out earlier today, even when there are voices pointing out these problems, the regulators couldn’t seem to find them because they wanted to “be collegial”. Collegial could also have described the relationship between Arthur Anderson and Enron, no? But of course, I’m overreacting… These are honest government employees with only the public’s interest at heart, so I’m sure there were no conflicts of interest…

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  • TerryP

    The sad thing is even when the accounting frauds happened and the regulators started doing their jobs, Congress (mainly Democrats) lashed out at the regulators telling them to essentially to go back to doing nothing because Fannie and Freddie are just fine. They are doing exactly what we want them to do. I have seen some of the Youtubes on when this happended and it is almost pathetic to see the regulators getting their butts chewed for finally doing their jobs. And we wonder why we are in the mess we are today.