As regular readers of this blog know, under the FDR Framework, regulators are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. So the ECB and BoE focus on removing opacity properly reflects this responsibility.
Common sense says that if the goal is to remove opacity, then the starting point is to know what elements of structured finance securities contribute to making them opaque. Without doing this analysis, how could the ECB or BoE know if they had removed opacity?
Each specific aspect of the regulators' responsibility can be linked to an element of the structured finance security. For example, regulators could look at when information is disclosed and match this to the issue of timely disclosure.
The result of this simple analysis is a matrix. Across the top in the columns are the issues the regulators are responsible for under the FDR Framework. Down the lefthand side in the rows are the different types of structured finance securities.
Included in the rows are subprime mortgage backed securities. These securities are synonymous with opaque, toxic securities.
Had the regulators looked at when loan-level performance information was disclosed for subprime mortgage backed securities, they would have found that it was done on a once per month basis. Did this once per month disclosure of loan-level performance data contribute to the hundreds of billions of dollars of losses on subprime mortgage backed securities?
Goldman bought Litton in 2007 [it had an investment made years earlier in Senderra, another subprime originator and servicer] for about $430 million. At the time, many banks looked at buying servicing arms to gain useful information about home loan performance for their mortgage bond trading businesses.What useful information about home loan performance would a servicing company have? It would have current information on how each loan was performing. By comparison, the investors in the subprime securities would receive out of date loan-level performance data in the once per month disclosure.
The fact that banks purchased servicing companies for current loan-level performance information confirms the fact that they were aware that they were buying tomorrow's news today and using it to trade against investors.
However, to be fair, the ECB and BoE also would have had other responses to their Public Consultations. If the composition of the respondents to the ECB and BoE Public Consultations were similar to what the Committee of European Bank Supervisors received on its related Public Consultation, my response would have been the only one in favor of providing current information. The rest, since they came from representatives of the sell-side would have preferred the status quo.
Presumably, the responses from the sell-side were ignored or at least highly discounted. After all, the ECB and the BoE knew from the January 2009 Group of Thirty report (co-authored by Jean-Claude Trichet and Mervyn King) that when it came to reforming structured finance, they were suppose to listen to the responses from everyone other than the sell-side firms, law firms representing the sell-side and lobbying organizations like AFME that are controlled by the sell-side.
So what did the ECB and BoE decide with regards to once per month loan-level performance disclosure?
The ECB and BoE decided that the opacity of once per month loan-level performance disclosure was adequate transparency for market participants, including themselves, to evaluate the risk of and price structured finance securities.
Let me repeat that. The ECB and the BoE decided that for restoring investor confidence in the structured finance market and managing the risk of structured finance securities on the ECB's and BoE's balance sheet it was preferable to be valuing the unknown contents of a brown paper bag than valuing the known contents of a clear plastic bag.
In doing so, they revealed a preference for stale, out of date information over fresh, current information. They also revealed a preference for maintaining the status quo and allowing Wall Street to trade with the informational advantage of having tomorrow's news today.
Given that the ECB's ABS Data Warehouse embraces once per month disclosure, why should it succeed in restoring investor confidence in structured finance?
Investors are smart enough to know and have experience that shows if Wall Street has an informational advantage, Wall Street will use this informational advantage to the detriment of the investors. Other than blindly chasing yields because central bankers keep rates low, what would ever cause an investor to purchase a structured finance security given that Wall Street knows what they are buying and the investor does not?