I thought I would share with the readers of this blog several of the weaknesses identified by the economists.
- There is a big difference between the data disclosure required under the FDR Framework and useful information. Yes there is, but fortunately for me market participants have honed the skill of analyzing large quantities of data and transforming this data into useful information. It is not surprising that market participants have honed this skill as it allows them to make a lot of money.
- Not all market participants are capable of analyzing the data. That is true. The participants who are not capable of analyzing the data have two choices: do not invest where they are not capable of analyzing the data or hire someone who is capable of analyzing the data. Most individuals go the later route and hire portfolio managers. These managers might in turn hire the relevant expertise.
- Market participants do not always analyze the data correctly. The same is true of regulators. Common sense suggests that the more market participants and regulators that are analyzing the data, including competitors, the more likely it is that some of the participants will do the analysis correctly.
- Asset and liability-level data is manipulatable. If we are talking about mark-to-market where banks choose between three different choices, yes it is. If we are talking does the asset or liability exist for financial reporting, no it is not as it is the role of accountants to record all the assets and liabilities. This even includes those assets that an artificial or capital arbitrage transactions like an SIV is designed to take off the balance sheet.
- It does not address the implicit guarantees of the too big to fail banks. Actually it ends these guarantees. By making the data available to all market participants, everyone knows when an institution is close to insolvency (the market value of its assets is less than the book value of its liabilities). When this happens, there will be market discipline on the regulators to close the financial institution before the taxpayers have to absorb any losses.
- It does not solve the problem of financial fragility. Perhaps not, but it makes many aspects of financial fragility more manageable.
- One source of financial fragility is the credit cycle. By providing current data, it improves market participants ability to monitor a loan portfolio and detect any deterioration in performance.
- Another source of financial fragility is the interconnectedness of the financial institutions. By providing current data, it improves each market participants ability to manage the price and amount of their exposure to each financial institution. This in turn reduces the potential for contagion as each market participant will tend to limit their exposure to what they can afford to lose as a financial institution approaches insolvency.