What is the most important lesson from financial crisis?

Updated: Monday May 4, 2009 MYT 11:32:51 AM

What is the most important lesson from financial crisis?

OMAHA, Nebraska: Billionaires Warren Buffett and Charlie Munger said Sunday the most important lessons of the recent financial turmoil are that companies should borrow less and build a system of severe disincentives for failure.
Berkshire Hathaway Inc.'s top two executives offered that frank assessment of businesses' role in the current recession at a news conference held a day after 35,000 attended the company's annual meeting in Omaha.
The two men also said most of the nation's biggest banks are not too big to fail, but consumers shouldn't be worried about bank failures because of the protections built into the system.
Buffett said having severe disincentives for failure and proper incentives for success is key to ensuring large financial institutions are run well.
He said people didn't become more greedy in the last decade, but the system allowed people to take advantage of it.
"I think the most important lesson is the world needs a whole lot less leverage," said Buffett, who is Berkshire's 78-year-old chief executive and chairman.
In speaking of disincentives, Buffett suggested that if an executive would be shot if the company fails, then the company would definitely borrow more carefully.
Buffett said Fannie Mae and Freddie Mac show that intense regulation can't prevent problems because those mortgage finance firms were some of the most regulated companies before government seized control of them amid mounting mortgage losses.
But Buffett said assigning blame for the economic mess doesn't make a ton of sense because so many people made mistakes.
"I think that virtually everyone associated with the financial world contributed to it," Buffett said.
Munger, Berkshire's 85-year-old vice chairman, said a combination of factors caused the financial mess.
He said the nation tolerated way too much debt, immorality and stupidity, and now it's paying the price.
"We have failed big-time on multiple fronts," Munger said.
He said gross immorality persisted in the consumer credit and derivatives businesses, and many people were taken advantage of.
Then the accounting profession failed to catch problems and tolerated too much foolishness, Munger said.
He said accounting rules that allow companies to report huge profit just before failing doesn't make sense.
"We do not need insane accounting that rewards people that can't handle the temptation," Munger said.
But it still might be hard to get Congress to pass sensible rules for investment banks and derivatives, Munger said, because of the amount of lobbying investment banks have done.
"We're going to have a hell of a time getting this fixed the way it should be fixed," Munger said.
Buffett said he's not sure how the government will handle the results of the stress tests officials are conducting on the 19 largest U.S. banks, but he doesn't think the government should rule out the failure of most of the banks.
"These 19 banks are not too big to fail," Buffett said.
"You can make a deal for any but the top four on the list."
To prove his point Buffett pointed to the examples of Wachovia and Washington Mutual banks, which both failed in the past year and were sold to competitors.
The stress tests are supposed to determine which banks would need more cash if the economy weakens further.
Federal Reserve officials have said the banks will be required to keep extra capital on hand in case losses escalate, which means some banks would be forced to raise money.
Buffett said consumers should not worry about bank failures because the Federal Deposit Insurance Corp. is there to protect them with the resources it collects by charging banks fees, so taxpayers don't pay when the FDIC rescues banks.
"I'm not worried at all about a run on the banks," said Buffett, whose company holds large stakes in Wells Fargo & Co., US Bancorp, M&T Bank, Bank of America and Sun Trusts Banks
Given the age of Buffett and Munger, there is always speculation on who might replace them.
Buffett said Sunday that investors would know if either had health problems.
"If I know of anything serious - or anything that might be interpreted as serious - health problems, Berkshire would disclose it," Buffett said.
"We don't want rumors flying around."
But Munger joked there might be a high threshold for disclosing anything about his health: "In my case, I'm so nearly dead anyway that it's a minor detail."
Both Munger and Buffett said they feel great.
Berkshire's Class A stock lost 32 percent in 2008, and Berkshire's book value - assets minus liabilities - declined 9.6 percent, to $70,530 per share.
That was the biggest drop in book value under Buffett and only the second time its book value has declined.
But Buffett always measure's the company's book value performance in relation to the S&P 500, which fell 37 percent in 2008, so he's not bothered by stock price fluctuations.
"We don't consider it our worst year by miles," Buffett said Sunday.
Berkshire owns more than 60 subsidiaries including insurance, clothing, furniture, and candy companies, restaurants, natural gas and corporate jet firms.
Berkshire also has major investments in such companies as Coca-Cola Co. and Burlington Northern Santa Fe Corp.

On the Net: Berkshire Hathaway Inc.: www.berkshirehathaway.com
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