FDR Framework and financial markets over-reacting

One of the strengths of the FDR Framework is that adherence to it keeps governments out of making observations about prices in the market.  There is no need to since the market participants have all the useful, relevant information in an appropriate, timely manner.

In the absence of this type of disclosure, governments are prone to talk about prices.  The question is:  do they have any credibility when they do so?

Before the credit crisis, the answer was yes.  Market participants knew they had a monopoly on all the useful, relevant information for financial institutions and trusted that governments knew how to use this data.

After the credit crisis, the answer is no.  The credit crisis showed that relying on the analysis by governments was no substitute for doing your own homework.  This has been confirmed in Europe with the last two stress tests.

According to a Telegraph article, EU president Herman Van Rompuy ventured into the discussion of prices by observing that financial markets are over-reacting.

He said jittery traders had behaved in a “fundamentally disproportionate” manner during the past fortnight, seeking out safe haven currencies and causing global markets to rollercoaster. 

Speaking on Belgian radio station RTBF, Mr Van Rompuy also ruled out issuing common eurobonds until what he described as “genuine budgetary convergence” within Europe. 

“Markets aren’t always right,” he said in the interview. “We could have eurobonds on the day...when everyone is in balance or virtually in balance.” 

Mr Van Rompuy cited the overvalued Swiss franc, which has soared by 14pc in value since the start of the year, as an example of investors’ insecurity. 

He said unwarrented panic had sparked the mass selloff of Italian and Spanish government bonds, which prompted the intervention of the European Central Bank earlier this month. 

“If the Swiss franc becomes a safe haven currency, it’s because something fundamentally disproportionate is going on in the world’s markets,” he said. 

Regular readers know that it is a lack of disclosure that is behind the market's reaction.  Without current asset and liability-level data, the market cannot tell who is solvent and who is insolvent.  As a result, the market is assigning a higher risk to everyone.

... The EU president said a better solution could be found in last month’s plan to give more flexibility to the eurozone’s €440bn (£384bn) rescue fund, which he urged governments to ratify as quickly as possible. 

While European growth slowed during the first half of this year, the region still shows signs of a healthy recovery and is likely to avoid recession, the EU president added. He said the risk of economic break-up within Belgium or the eurozone was “fiction”. 

Mr Van Rompuy said a six-part package of laws to strengthen European rules on national deficits is expected to be passed next month, with emphasis on an improved communications policy to boost investor confidence and dampen disagreements between governments. 

“We have to try to give the same message. It’s inevitable that there will be several voices. But everyone has to convey the same message,” he urged.

It is far easier to get everyone on the same page on disclosure.