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Monday, Mar 1, 2010 5:02 PM UTC

Warren Buffett: The risk stops here

In his annual letter to shareholders, the Berkshire-Hathaway CEO delivers a message to his Wall Street peers

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Topics: U.S. Economy, How the World Works, Bolivia,

Whether you think Warren Buffett’s annual letter to the shareholders of Berkshire-Hathaway is refreshingly plainspoken or deceptively homespun, the missive is always an interesting read, if only because of the strong sense that there is an actual real person behind the words, rather than a highly paid team of public relations agents.

For example, the following passage, in which Buffett delivers a not-so-implied criticism of your average financial institution CEO, rings true with some heartfelt disgust.

Charlie [Munger] and I believe that a CEO must not delegate risk control. It’s simply too important. At Berkshire, I both initiate and monitor every derivatives contract on our books… If Berkshire ever gets in trouble, it will be my fault. It will not be because of misjudgments made by a Risk Committee or Chief Risk Officer.

In my view a board of directors of a huge financial institution is derelict if it does not insist that its CEO bear full responsibility for risk control. If he’s incapable of handling that job, he should look for other employment. And if he fails at it — with the government thereupon required to step in with funds or guarantees — the financial consequences for him and his board should be severe.

It has not been shareholders who have botched the operations of some of our country’s largest financial institutions. Yet they have borne the burden, with 90 percent or more of the value of their holdings wiped out in most cases of failure. Collectively, they have lost more than $500 billion in just the four largest financial fiascos of the last two years. To say these owners have been “bailed-out” is to make a mockery of the term.

The CEOs and directors of the failed companies, however, have largely gone unscathed. Their fortunes may have been diminished by the disasters they oversaw, but they still live in grand style. It is the behavior of these CEOs and directors that needs to be changed: If their institutions and the country are harmed by their recklessness, they should pay a heavy price — one not reimbursable by the companies they’ve damaged nor by insurance. CEOs and, in many cases, directors have long benefitted from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well.

It is instructive to compare Buffett’s sense of corporate responsibility with a brief snippet from “The Big Short,” Michael Lewis’ superb new book on the financial crisis (not officially published until March 15th, but beginning to trickle out here and there via excerpts).

Lewis devotes much of “The Big Short” to a short-seller named Steve Eisman who becomes convinced that the entire subprime mortgage industry is a house of cards — with special emphasis on the securitization games being played by the big Wall Street investment banks. (Italics mine.)

On the surface, these big Wall Street firms appeared robust; below the surface, Eisman was beginning to think, their problems might not be confined to a potential loss of revenue. If they really didn’t believe the subprime mortgage market was a problem for them, the subprime mortgage market might be the end of them. He and his team now set about searching for hidden subprime risk: Who was hiding what? “We called it The Great Treasure Hunt,” he said…. He’d go to meetings with Wall Street CEOs and ask them the most basic questions about their balance sheets. “They didn’t know,” he said. “They didn’t know their own balance sheets.”

As we watch the parade of Wall Street lobbyists and CEOs complain about what new financial regulation will mean for their businesses, we should remember that their own record suggests that they don’t have a very good handle on what they’re actually doing, and their self-inflicted wounds, absent a government bailout, would have been far more lethal than anything coming out of Washington.

Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21. More Andrew Leonard.

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