Go Away, Complex Financial Products

I’m glad the New York Times scraped together enough dough to send Dealbook’s Andrew Ross Sorkin to Omaha for the Berkshire Hathaway annual meeting. Among the Buffett-isms that Sorkin blogged about yesterday was this pronouncement about complex financial products:

“If you need to use a computer or a calculator to make the calculation, you shouldn’t buy it.”

A calculator? Really, Warren?

Still, Mr. Buffett is dead serious when he tells investors not to buy financial instruments that are too complicated for them to understand. And he’s not the only one saying this. Since the subprime meltdown, many titans of the financial world have been touting the joys of simplicity, to the point where I find myself wondering if they’re all reading Real Simple magazine – albeit, to my knowledge, Mr. Buffett has not yet suggested any wonderful new uses for rubber bands.

Thomas Hoenig, head of the Kansas City Fed and subject of my last post, expressed disdain for financial complexity during his talk on Monday at Demos. I particularly loved this observation: “When someone says it’s too complicated for you to understand, that means they don’t understand it either.”

OK, but without making Quakerism the official religion of Wall Street (which unfortunately would violate the First Amendment), how can you enforce simplicity in the financial system? Is it possible to write laws and regulations to stop financial innovators from hiring high-IQ quants and falling back into smartypants mode?

I don’t think so. You have to get at this issue indirectly, and I think Mr. Hoenig has the right idea: The fiduciary duties of financial institution boards must include the duty of understanding what the heck is going on. Each director should comprehend every business line enough to feel confident that it’s well-managed. So if you’re a director and no one at the joint can explain a financial product in a way that makes sense to you, says Mr. Hoenig, “you tell them to get out of the business.”

Yeah, and if the CEO protests, just shoot him with a rubber band.

image credit: www.ikon-gallery.co.uk