Sunday, July 1, 2012

"At the root of all financial crises is a lack of transparency"

In his Telegraph column, Bedlam Asset Management's Jonathan Compton supported the observation that a lack of transparency is at the root of all financial crises by offering
“The primary purpose of any joint stock enterprise from healthcare to banking is to make its owners money. The optimal structure is a monopoly. Next best is to collude with competitors to control prices. This is inherently more efficient in private because it prevents competition. As collusion is always unpopular, participants must be over-rewarded for their silence.”...
The hysterical reaction to the widening Libor price-fixing scandal demonstrates a lack of knowledge of how businesses have worked since the first caveman made an axe (doubtlessly then killing his neighbour who was designing a better model). 
The number of participant banks and employees worldwide make it inconceivable that these arrangements were not generally known. Globally, “bbalibor” covers 10 currencies, each with 15 maturities - ie interbank interest rates over various periods - making 150 rate fixings every business day. 
And it was known - there were many good articles on the topic from 2007. 
This leaves bank directors, regulators and politicians with unpleasant choices. Either they were unaware, and so incompetent; or they knew but carried on, so were reckless and skirting with criminality. 
Most probably they chose not to look, so were negligent. 
This conclusion is supported by the findings of the Nyberg Report on the Irish financial crisis.  The primary conclusion is that bankers, directors, regulators and politicians chose not to look.
Another serious implosion in the financial system will increase the already high and often justifiable mistrust ....
At Bedlam we at least tried to start in the right place, and so hold no financial companies for clients. This was also the case for three years from 2006, not because we foresaw the specifics or timing of the crash, but because the balance sheets of banks and insurance companies were so opaque as to defy analysis..... 
Yet financial shares remain unattractive because the Libor fiasco should be a game changer. 
Since 2007 there has been a woeful lack of reform. 
Hopefully, the pressure is now sufficient that the Bank, the Treasury and politicians will develop rudimentary spines and do what they have long promised ....

Sadly, other necessary and larger reforms will be ducked. At the root of all financial crises is a similar fault - a lack of transparency. 
If all trades can be seen and tracked, the scope for fraud diminishes. 
Yet regulators maintain a hostile twitch to real transparency. Not only does transparency reduce their power and purpose, it casts an unwelcome light on how they operate, from the arcane and opaquely appointed Court of Directors of the Bank of England through to the multiple failures of both the Bank and Financial Services Authority.
Please re-read the highlighted text as Mr. Compton has summarized the buy-side's view of the lack of reform that addresses the underlying causes of the on-going financial crisis and the need for real transparency.

Your humble blogger has discussed the impact of transparency on regulators.  It strips them of the ability to pursue the Japanese model for handling a bank solvency led financial crisis.

With transparency, regulators can no longer engage in policies like regulatory forbearance that protect meaningless book capital levels at the expense of the real economy.

With transparency, regulators are no longer a single point of failure that can bring down the financial system.  With transparency, market participants are no longer dependent on them to properly assess the risk of each bank and the financial system.  Instead, market participants can independently assess the risk of each bank for themselves and adjust the amount and price of their exposure to each bank to reflect its risk.

With transparency, regulators are forced to adopt the Swedish model and allow the modern banking system to operate as it is designed.  With transparency, market discipline is brought on the banks to recognize all the losses that are currently hidden on and off their balance sheets today.  Subsequently, banks can support the real economy and rebuild their book capital levels through retention of 100% of pre-banker bonus earnings.

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