Friday, February 11, 2011

Warren Buffett, Too Big to Fail meet Current Asset-Level Disclosure

Bloomberg reported that in his testimony to the Financial Crisis Inquiry Commission, Warren Buffett commented,
... taxpayers will always be on the hook for collapses at the biggest U.S. companies. 
True, but that does not mean that steps should not be taken today that would minimize the potential for taxpayer losses.

The critical step is to require financial market participants to provide genuine transparency.  They must disclose all useful, relevant information in an appropriate, timely manner.  This would include reporting current asset-level data on an observable event basis.

It is this data that market participants need to assess the risk and solvency of an individual firm.

It is this data that allows market participants to properly value any money they lend to or invest in a firm.  This in turn allows the market participants to exert market discipline when a firm's risk profile changes.
“You will always have institutions that are too big to fail, and sometimes they will fail,” Buffett, 80, told the FCIC in a May 26 interview, according to a recording released by the panel yesterday. “We still have them now. We’ll have them after your commission report.” 
The idea of breaking up the Too Big to Fail has been championed in a number of quarters.  It is still being discussed by the Independent Commission on Banking in England.

At best, it is a poor substitute for current asset-level disclosure.

Long Term Capital is an example of why breaking up a firm does not generate nearly the same systemic risk reduction as current asset-level disclosure.  Long Term Capital was not very big and it needed the Fed to organize a bailout to avoid a systemic problem in the credit markets.

If current asset-level disclosure had been required of Long Term Capital, it would not have been able to take anywhere near as much risk.  The other market participants would have been able to see the risk it was taking.  Credit analysts would have been publicly talking about the risk.  As a result, the other market participants would have adjusted the cost of borrowing so that Long Term Capital would have stopped adding to its total positions much sooner.

For the same reason that Long Term Capital would have been smaller and represented much less systemic risk, current asset-level disclosure will have the same impact on today's Too Big to Fail.

This is the data that Jamie Dimon, Gary Cohen and Peter Sands called for at Davos.  

Current asset-level disclosure is a very good thing, because it does not require governments to tell financial institutions how to reduce their risk profile.  Instead, under pressure from other market participants who can now properly assess their risk, each of the Too Big to Fail will have to decide how to reduce their risk profile for themselves.
...“I do think that if you ran into a similar situation today the government would guarantee commercial paper again. They’d have to,” Buffett said. “You have to believe the government, the federal government, will act and they will act promptly and decisively.”
Actually, your humble blogger would like to believe that the government has learned its lesson from the recent financial crisis and will require current asset-level disclosure so that it is never again faced with a similar situation.
Berkshire bought preferred stock in New York-based Goldman Sachs ... 
“It was a bet essentially on the fact that the government would not really shirk its responsibility at a time like that,” Buffett said.
Hopefully, governments around the globe will not shirk on their responsibility now.  As has been laid out repeatedly on this blog under the FDR Framework, governments are responsible for ensuring that market participants have access to all useful, relevant information in an appropriate, timely manner.

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