The FDR Framework passed the test of time

Recently, this blog has spent a considerable amount of time discussing the ECB's ABS data warehouse.  This data warehouse has served as an excellent example of the problems, like opacity and conflict of interest, in our financial system that result from the failure to adhere to the FDR Framework.

As regular readers of this blog know, the FDR Framework, with its philosophy of disclosure combined with the principle of caveat emptor [buyer beware], has been with us for almost 80 years.

Your humble blogger never tires of pointing out that the financial markets did not stop functioning during the recent credit crisis in those areas that adhered to the FDR Framework.  In these areas, market participants had access to all the useful, relevant information in an appropriate, timely manner.  Market clearing prices may have declined, but there were investors standing willing to buy the securities being offered.

The financial markets failed in those areas, structured finance and unsecured debt securities of regulated financial institutions, that did not adhere to the FDR Framework.  In these areas, market participants did not have access to all the useful, relevant information in an appropriate, timely manner.  Market clearing prices in these areas disappeared as there were few investors standing willing to buy the securities being offered.

Your humble blogger out of necessity keeps reminding economists and regulators that the FDR Framework has an incredibly good predictive track record.  This track record applies to both predicting market failure before the credit crisis as well as predicting the failure of different regulatory responses to restore investor confidence (see posts on Irish banks and Spanish Cajas) subsequently.

Perhaps more importantly, the FDR Framework lays out a coherent explanation for why the financial crisis occurred (no need to ignore any inconvenient facts) and what has to be done to fix the financial system.

The FDR Framework is parsimonious.  It is the model of how the financial system works that requires the fewest assumptions and has the best predictive value.