Tuesday, November 29, 2011

How Paulson gave hedge funds advance word

Bloomberg has another terrific article on the problem with regulators having a monopoly on the useful, relevant information for financial institutions.

In this case, the article discusses a meeting between then US Treasury Secretary Hank Paulson and a group of hedge fund managers.  At the meeting, Paulson discussed Fannie Mae, Freddie Mac and the possibility that the government might put them into receivership.

The reason that I highlighted the article are the following paragraphs

Morgan Stanley and BlackRock Inc. both helped the Federal Reserve and OCC prepare the reports on Fannie Mae and Freddie Mac that Paulson told the New York Times would instill confidence the morning of [July 21, 2008 when he and hedge fund managers attended] the Eton Park meeting.

Paulson learned by mid-August that the Federal Reserve had found the GSEs “unsafe and unsound,” he told the Financial Crisis Inquiry Commission, which was appointed by President Barack Obama and Congress to probe the causes of the financial collapse. 
“We’d been prepared for bad news, but the extent of the problems was startling,” he wrote in “On the Brink.”
The Federal Reserve and the OCC had Morgan Stanley and BlackRock Inc. prepare reports on Fannie Mae and Freddie Mac with the intent of instilling confidence in the market.

Why exactly are the Federal Reserve and OCC having reports written to instill market confidence?

This blog has repeatedly said that the only way to instill market confidence is to disclose all the useful, relevant information in an appropriate, timely manner.  Market confidence flows from market participants being able to use this information to independently assess the risk of an exposure.

The fact that the Federal Reserve and OCC were in a position to consider having these reports written is a function of the fact that the regulators' monopoly on all the useful, relevant information meant that there was inadequate disclosure to market participants.

Like all financial institutions, Fannie Mae and Freddie Mac should be required to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

Mr. Paulson confirms that there was a regulatory failure to properly assess the information from Fannie Mae and Freddie Mac on which the regulators have a monopoly.

This is another problem that would be resolved with ultra transparency.  The market participants could help the regulator by providing them with their assessments.

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