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Special Series
Most Transparent Markets
For more reading on transparent markets, please read all parts of the series: Part I, Part II
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Yesterday we talked about "transparent markets," and examples of practices that are not transparent. We saw that these practices were in fact "the way it's done" at Wall Street's biggest investment banks, with the full knowledge of ratings agencies and regulators.
I also quoted Treasury Secretary Henry Paulson repeating Wall Street's article of faith about U.S. markets being the world's most transparent, from his speech arguing that too many lawsuits and too much regulation now threaten U.S. competitiveness.
A word about lawsuits and regulators: I agree that there's too much of both. I also believe that the issue goes way beyond threats to competitiveness. Lawsuits, the fear of lawsuits, and stupid legislative "reforms" like Sarbanes-Oxley have done outright harm to the U.S. economy for a very long time. Annual tort costs alone exceed two percent of GDP. But these problems duly noted, lawsuits and regulations ain't what caused the current debacle (and if anything, fallout from the subprime/credit crisis is certain to produce an entire new class of lawsuits and stupid legislation).
Yes, I'll be the first to acknowledge that hindsight is 20/20 -- there's not much rocket science in figuring out why something blew up after it explodes. At the same time, it is fair to point out that any rational assessment of risk -- whether risks to competitiveness, or systemic risks to the financial system itself -- must begin with probabilities. I say this because it is hard to imagine a scenario whereby the broken tort system or excessive regulation would cause behemoths like Bear Stearns, Lehman, and AIG to implode in a matter of days. On the other hand, it is easy to imagine the rapid demise of any financial institution, if its depositors/shareholders suddenly lose confidence in the quality of that institution's capital reserves and health.
And that is precisely what happened to Bear, Lehman, and AIG. Depositors, shareholders and other clients suddenly suspected that capital reserves were valued in ways that weren't so "transparent" after all. The equivalent of a bank run followed. Furthermore, when the Fed's bailout left the stock price at pennies on the dollar, shareholders got a full dose of the brutal truth regarding transparency.
How many investors would have purchased those shares to start with, had they known that the biggest firms on Wall Street treated illiquid assets as "securities," and counted unsecured debt as "capital"? In other words, if U.S. financial markets really are the most transparent in the world, investors should be able to safely assume that securities and capital are just that.
Now, if you won't be able to sleep until you know all the details about how the SEC could go along with something this outlandish, go to a search engine and type in "Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities." What you find may well succeed in boring you to sleep (if not tears) before you're done. If the short version will do, here's how one financial columnist described it: "It looks to me as if the inmates are running the asylum."
And, finally, now that you know what the regulators were not doing, there's the question of what they were doing. Keeping in mind that regulators actually regulate participants in a given market, let me summarize:
a) They never regulated market participants with the greatest potential of blowing up the system, such as hedge funds and credit default swaps
b) They deregulated market participants such as Bear, Lehman & AIG, who depended on the unregulated market participants
c) They retained regulatory control over market participants that had the least potential of doing damage, such as short-sellers. Run a Google news search on "SEC" and "short sellers" to see what I mean.
I humbly suggest that when it comes to your portfolio and financial future, you can do without the inmates and their asylum. The only sane conclusion to draw is that you're better off looking after yourself. A good method will help -- click here to see what we see.