Washington Record On Safety And Soundness

by JoeTheEconomist October 12, 2011 10:39 AM

In 2008 we learned that Washington does not fully appreciate financial risk.  They failed to take any precautions, and described the events fast-moving.  In constrast, Warren Buffett warned us in 2002 about the dangers of derivatives.  In 2007 and well into 2008, Washingon continually underestimated the seriousness of the problem.  It produced one bad solution after the next.  From the "Super-Fund" to the Bear Bail-out, Washington always had an idea that was too little too late.

These events weren't unforeseeable.  Buffett forsaw the crisis, and built a 35 billion dollar reserve to take advantage of the crisis.   

Charlie and I believe, however, that the macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other….  In our view derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal..”

~Berkshire Hathaway Annual Report 2002

 Fair enough.  How successful has Washington been in protecting the safety and soundness of any system.  Let’s look at banking.  The government was surprised by the dangers of 35 to 1 leverage in the banking industry.  Washington described “derivatives” as useful tools held in the hands of well-capitalized sophisticated investors.   Half were, and the other half was in the hands of AIG.  Over a period of a few months, these investments wiped out Bear Stearns, Lehman Brothers, and AIG costing the tax payers hundreds of billions of dollars. 

How did you possibly miss the housing bubble? How could you say at the peak of this three-Sigma event--a one in 1,000 year event at the top of 2006--how could you say the U.S. housing market merely reflects a strong U.S. economy? Surrounded as you are by all this statistical help, and with your experience with the Great Depression, how could you miss it?

~Jeremy Granthom A Question For Ben Bernanke

Let’s look at housing.  In 2006, Washington said that the strength of housing prices reflected a strong economy.  Washington didn't just misgauge the housing market.  It suggested that the housing market was fine despite being a levels of overvaluation that occur about every 1,000 years. 

And you want to allow government to define how you can invest your retirement funds?

 

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