Opacity has a high price: EU response to sovereign debt and bank solvency crisis shows it

Opacity has a very high price.

First, there were the losses on the opaque securities sold before the solvency crisis began on August 9, 2007.  This includes the opaque toxic structured finance securities loaded with fraudulently underwritten sub-prime mortgages as well as CDOs like Abacus that were designed so that Wall Street could profit from the collapse in the sub-prime market.

The Bank of England's Andy Haldane estimated the losses from the opaque securities exceeded $4 trillion globally.

Second, there is the on-going cost of bailing out the banking system.  The banks themselves hid risk both on and off their opaque balance sheets.

Based on a chart showing actual US Debt versus its pre-crisis trend line by Diapason's Sean Corrigan, Zero Hedge suggests that this cost is $3.5 trillion.

Third, we have the EU's sovereign debt crisis which to a significant extent is the result of attempting to bail out the banks in 2008/2009.

Based on the tentative agreement reached by EU policy makers, it appears that the cost is at least 440 million euros - the "equity" that the EU is putting into the European Financial Stability Fund.

This tally of costs only looks at the direct costs of opacity.

Hidden are the indirect costs like zero interest rate policies that transfer wealth from savers to bankers (banks pay nothing for the deposits and can park them at central banks and earn a risk free spread).

In short, opacity has a very high price.

Unfortunately, so long as we have pockets of the financial system that remain opaque, the cost of opacity will keep increasing.

For example, in the Eurozone, bank balance sheets are opaque.  What this means is that no one, including the regulators, knows how much exposure any bank has to any other bank, to any sovereign or how the bank might be trying to hedge the risk of this exposure.

As a result, the options available to Eurozone policy makers and financial regulators in how to respond to the sovereign debt and bank solvency crisis are limited.

For example, how many times did the policy makers express fear of causing contagion.  This "fear" clearly influenced the negotiations over the size of the haircut on Greek debt.  The banks knew that the policy makers would not be willing to risk a blow-up of the Eurozone banking system.  Hence, banks could negotiate to minimize the haircut and receive a 30 billion euro credit enhancement.

Imagine how differently the negotiations would have gone if all market participants knew the intimate details of each bank's assets, liabilities and off-balance sheet exposures.  With this information, policy makers could have seen if it fact a 100% write down of the Greek debt would have triggered contagion.

[This blog has suggested on several occasions that disclosure is the cure for contagion.  I have argued that   as soon as the data is made available to the market, it is in each bank's best interest to adjust their exposures to the other banks so that their exposures are not more than they can afford to lose.]

However, the EU policy makers and financial regulators did not have disclosure.

• This is despite the fact that all of the assets, liabilities and off-balance sheet exposures are knowable facts since they are in each bank's information systems.  

• This is despite the fact that the EU policy makers and financial regulators had gone through the first stage of the financial crisis in 2008/2009 and seen that the the financial markets broke down everywhere that there was opacity and that the policies that they adopted then had failed to provide disclosure - actually, they bought time in which disclosure could have been implemented and the current round of the financial crisis avoided.

Instead, the EU policy makers and financial regulators were faced with opacity and the fear of the unknown.

The results were predictable.  Once again opacity extracted its high price.

Now the question is will the Eurozone policy makers end opacity by setting up a data warehouse to collect the current asset, liability and off-balance sheet exposures from each bank and providing this data for free to market participants.