Thursday, August 18, 2011

Not only is disclosure effective, it is also has a fantastic cost/benefit ratio

The Dealbook section of the NY Times carried an article on how Wall Street is attacking the regulations issued under Dodd-Frank by focusing on the cost of compliance and comparing it to the benefits of the regulation.

As discussed in an earlier post, Thank You Andy Haldane, the cost/benefit analysis for fully implementing the FDR Framework for all financial institutions and structured finance products goes as follows:

Your humble blogger would like to thank Andrew Haldane of the Bank of England for putting a value on asset-level transparency for both financial institutions and the products they produce.

As discussed on NakedCapitalism,
In a March 2010 paper, he compared the banking industry to the auto industry, in that they both produced pollutants: for cars, exhaust fumes; for bank, systemic risk. While economists were claiming that the losses to the US government on various rescues would be $100 billion ([Yves Smith] ahem, must have left out Freddie and Fannie in that tally), it ignores the broader costs (unemployment, business failures, reduced government services, particularly at the state and municipal level). His calculation of the world wide costs:
….these losses are multiples of the static costs, lying anywhere between one and five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. 
Yves Smith then goes on to relate the cost of systemic risk to transparency.
... opacity, leverage, and moral hazard are not accidental byproducts of otherwise salutary innovations; they are the direct intent of the [financial firms'] innovations. No one was at the major capital markets firms was celebrated for creating markets to connect borrowers and savers transparently and with low risk. After all, efficient markets produce minimal profits. They were instead rewarded for making sure no one, the regulators, the press, the community at large, could see and understand what they were doing.
As laid out in the FDR framework,  the government's role in the financial markets is to insure transparency and not to endorse specific investments.

Clearly the financial industry will balk at the cost of providing investors access to all useful, relevant asset-level information in an appropriate, timely manner.  However, this cost is orders of magnitude less than the cost of not having transparency quantified by Andrew Haldane.  As a result, there is no legitimate reason remaining for governments not to require asset-level data for both financial institutions and the products they produce.

In summary, the cost of providing current asset and liability-level data is measured in billions and the benefits to society are measured in trillions.

As the Dealbook article says,

Until now, Wall Street relied largely on an army of lobbyists to chisel away at 300 new rules flowing from the S.E.C. and the Commodity Futures Trading Commission, among other agencies. But while lobbying might yield the occasional loophole, judicial rulings can halt new rules altogether. 
“I would hope the agencies are taking to heart the potential consequences for Dodd-Frank rules,” said Eugene Scalia, the lawyer who won the proxy case on behalf of the Chamber of Commerce. 
Hal S. Scott, a professor at Harvard Law School and a director of the Committee on Capital Markets Regulation, a research group that has been a critic of Dodd-Frank, said, “I do see lots of challenges coming down the pike.” 
Regulators, reluctant to give in to industry pressure, are rushing to safeguard their rules from legal action. The commodity commission, having already delayed several Dodd-Frank rules for six months, is now studying the proxy case and considering adjustments to some proposed regulations, according to a person close to the agency. Earlier this month, the agency dispatched several staff members to meet with S.E.C. officials about the recent court decision. 
For its part, the S.E.C. is weighing an appeal of the proxy ruling. The S.E.C. is also adding economists, planning to hire eight over the next two years, after the appeals court rebuked the agency for not fully evaluating the proxy rule’s economic effects. 
The legal challenges are rooted in a 1996 law that requires the S.E.C. to promote “efficiency, competition and capital formation.” The law enabled the financial industry to build lawsuits around the economic costs of a rule, regardless of its merits.

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