Davos: Paul Singer versus the global financial regulators

One of the central themes of this blog is the always harmful substitution of the combination of complex rules and regulatory oversight for transparency and market discipline.

This theme played out in a Davos panel discussion involving Paul Singer from Elliott Management.

As reported on twitter by @Anthony_Reuben, a journalist on the BBC business desk:

Paul Singer says he sends his staff to find out about financial health of banks and they come back and shrug. Wants more disclosure. 

Mr. Singer's staff confirms the Bank of England's Andrew Haldane's observation that current bank disclosure standards leave them resembling 'black boxes'.

And why does Mr. Singer want more disclosure?  Because as an investor Mr. Singer knows that he should be responsible for all gains and losses on his exposures to banks.

Hence, he is looking for all the useful, relevant information in an appropriate, timely manner so he can independently assess this information and make a fully informed investment decision.

For banks, the useful, relevant information is their current global asset, liability and off-balance sheet exposure details.  What your humble blogger calls ultra transparency.

Why isn't this information available?

Prudential boss: global banking standards difficult because banks in countries where banking system didn't blow up are not interested.

It is not the banks that are uninterested, but it is the global financial regulators clinging to their information monopoly who are uninterested.

Here we are five years after the beginning of the financial crisis and Paul Singer's staff still cannot access all the useful, relevant information for making an investment in a bank nor is there any movement afoot to ever require banks to provide this information.

Everyone knows that ultra transparency is the "gold standard" for bank disclosure.  But it is more than that.  It is also gives banks in countries that adopt ultra transparency a competitive advantage.

The competitive advantage comes from the simple fact that ultra transparency allows market participants to independently assess the risk of each bank.  Since everything is disclosed, market participants can do a better job of assessing the risk and as a result can reward these banks with a lower cost of funds and a higher stock price.

All those banks in countries that don't require ultra transparency are at a competitive disadvantage.  Market participants know from the lack of disclosure that the banks are hiding something.  As a result, market participants punish these banks with a higher cost of funds and a lower stock price.

Ultra transparency is actually an easy global banking standard to adopt as there are no banks who would want to be at a competitive disadvantage.

So what do we have instead of ultra transparency?

We have the pursuit of the combination of complex rules and regulatory oversight.

This takes the form of legislation like the Dodd-Frank Act that was written by and for the banks (recently, I discovered that the Volcker Rule is essentially toothless as it was written so it doesn't apply to position held for more than 90 days ... proprietary bets can last months), we have financial regulators pursuing Basel III capital regulations that are too complex to enforce and we have policymakers pursuing ring-fencing.

This pursuit of the combination of complex rules and regulatory oversight shows that the first lesson of the financial crisis was not learned.  The first lesson is that the combination of complex rules and regulatory oversight failed.

The combination just didn't fail, it failed in a catastrophic manner as shown by our ongoing financial crisis.

Equally importantly, the financial crisis revealed that the combination of complex rules and regulatory oversight is prone to catastrophic failure.

Unlike Tim Geithner who believes that the combination of complex rules and regulatory oversight should be given another chance, your humble blogger does not believe in gambling with the stability of the financial system when it is your humble blogger and the other taxpayers who are going to be called on to bail out the financial system when this combination predictably fails again.

Ultra transparency restores stability to the financial system and does away with gambling financial stability on the success or failure of complex rules and regulatory oversight.

BoE's Andrew Haldane: changes coming to "too complex" bank capital rules

Reuters reports that the Bank of England's Andrew Haldane has told British MPs that changes are coming to both "too complex" bank capital regulations and bank accounting rules.

In both cases, the changes are aimed at getting the regulation and rules to better reflect reality.

Regular readers know that even though these are steps in the right direction, at the end of the day we are still talking about the combination of complex rules and regulatory oversight being substituted for the combination of transparency and market discipline.

The number one lesson from the financial crisis is that the combination of complex rules and regulatory oversight doesn't work and the continued pursuit of this combination will result in another financial crisis.

Requiring banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details would be far more effective in preventing future financial crises than the modest improvements Mr. Haldane is suggesting might occur in bank capital regulations and accounting rules.

Bank capital rules coming into force this month are too complex and efforts to simplify them are already underway, a senior Bank of England official said on Monday. 

Andrew Haldane, the bank's director of financial stability, was among the first senior regulator to question Basel III, the world's core regulatory response to the 2007-09 crisis, that led to banks being bailed out by taxpayers. 

Basel III, agreed by world leaders, forces lenders to hold more capital, but Haldane says it is too complex and relies on banks using their own models to determine capital buffers. 

He told British MPs there was an increasing awareness among international regulators they may have taken a "false turn in the road" by backing Basel III which was written by the Basel Committee. 

"Regulators cannot really police this complex beast," Haldane said. "There are moves afoot with the Basel Committee to seek ways to simplify and streamline the move to a proper regulatory rather than self-regulatory edifice. That may take some time."....

Regulators can't police even the simplest bank capital rules.  It frankly isn't in their job description.

The question that financial regulators ask is 'does the bank have enough capital to absorb the potential losses from the exposures on and off its balance sheet?'  The answer is either the bank has enough capital to absorb the potential losses or it does not regardless of what its capital ratio might be.

That global financial regulators have a tough time answering the capital adequacy question has been shown many times over the last few years when banks that passed the regulators' stressed tests subsequently needed another bailout or to be nationalized.

The Basel Committee said earlier this month work on reviewing in-house models would be accelerated this year. 

"There is a big straw in the wind ... The big trend here is the retreat is from in-house models," said Simon Gleeson, a financial lawyer at Clifford Chance....

But Haldane said Britain won't wait for Basel's work to finish and the Financial Services Authority watchdog was already forcing banks to use simpler models for totting up risks from commercial property on their books. 

"There is no reason why they could not do that across a wider set of portfolios," Haldane said. 

There was also nothing to prevent UK regulators from imposing "floors" below which capital levels could not fall irrespective of what internal models show, Haldane added.

All of this is simply rearranging the deck chairs on the RMS Titanic.

He is member of the bank's Financial Policy Committee (FPC), which sets the tone and direction for regulation in Britain. From April, the bank becomes the regulator for lenders.

There was also support on the FPC for a higher leverage ratio or balance-sheet cap on banks than the 3 percent set under Basel III, he said....

Accounting rules used in the EU, drawn up by the International Accounting Standards Board, were also "not as prudent as they could and should be for financial firms," he said, arguing the rules failed to ensure banks make early provisions on souring loans and also lead to under-recognition of losses. 

Reforms to accounting rules put forward by the IASB and its U.S. counterpart were still "unfinished business" and therefore Britain was asking banks directly to make bigger provisions than they need to under accounting rules. 

"We are working privately with FSA and auditing firms to see if we can't at least provide better disclosure about fair value gains and losses than is the case right now," Haldane said. 

The UK authorities are thrashing out a "prudent valuation framework" to put a price tag on illiquid or toxic assets, and force banks to make deductions from their capital buffers.

Excuse me, but it is the role of the markets and not the financial regulators to value financial securities.

Since the beginning of the financial crisis it has been abundantly clear that the market cannot value opaque securities like the 'black box' banks or the 'brown paper bag' structured finance securities.

Common sense suggests that the regulators' time would be better spent bringing transparency to all the opaque corners of the financial system rather than creating unenforceable regulations.

"We might in time be able to inject a notion of prudent valuation into accounting," he added.

Actually, if banks were required to provide ultra transparency it would be unnecessary to inject the notion of prudent valuation into accounting.

Market participants would simply adjust each banks' accounting numbers for the difference between the actual value of the bank's assets and the reported value.

Bank of England's Andrew Haldane: traditional banking model, R.I.P.

In his testimony before a Parliament committee, Reuters reports that the Bank of England's Andrew Haldane observed that banks need a new business model.

Banks need a new business model and the threat of forced separation of investment and retail banking should be put into law to help curb risky behaviour... 

The question is what should the new business model be?

The financial crisis confirmed for all time that banks are bad holders of risk.  This includes credit, interest rate and liquidity risk.

This should come as no surprise given past financial crises:  Loans to less developed countries (credit), US Savings and Loans (interest rate) and the Great Depression (liquidity).

It was this recognition that banks were bad holders of risk that drove the creation of the 'originate to distribute' model.  Under this business model, banks were suppose to transfer these risks to other financial market participants who were better able to hold these risks.

Clearly, the 'originate to distribute' model failed in the run-up to the Great Recession.  The key question is why?

It failed along two correctable dimensions.

First, it failed because of a lack of transparency in the securities that were sold to transfer the risk.  Structured finance securities from covered bonds to securitizations are brown paper bags where buyers are blindly betting on the value of the contents.

This is correctable by simply requiring observable event based reporting on all activities like payments or delinquencies involving the underlying collateral before the next business day.  With this information, market participants can know what they are buying (which exerts market discipline on the pricing of the underlying collateral) and, on an ongoing basis, know what they own.

Second, it failed because of a lack of transparency into the banks themselves and the risks that they were taking on.  Banks are, in Mr. Haldane's words, 'black boxes.'  As such, they are not subject to market discipline as market participants cannot figure out how risky the banks are.

Instead, the financial system is dependent on regulators to both correctly assess and communicate the risk of the banks.  The failure by regulators to do both correctly (and regulators are biased to not properly communicate the riskiness of the banks over concerns about "safety and soundness") results in the potential for financial contagion as market participants have too much exposure given the real risk of the banks.

This too is correctable by simply requiring ultra transparency and having the banks disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

The new business model should be the 'originate to distribute' model with transparency.

This business model restrains risk taking by banks while assuring that the economy has the access to credit it needs for growth.

Andrew Haldane, director of financial stability at the Bank of England, told a panel of lawmakers that Britain's Vickers plan to impose extra capital on the deposit-taking arms of banks by 2019 to make them safer, may not be enough to protect the taxpayer.... 

Haldane urged them to consider inserting a "backstop" so that if the "ring fence" leaked or was hard to police, regulators could forcibly split up the banks into retail and investment units. 

"That could be a clever way of ensuring Vickers is implemented faithfully and achieves what it is meant to achieve," Haldane said. 

Regular readers know your humble blogger is not into "clever", particularly when it involves financial regulation.  Clever is what drives the creation of complex rules/regulations like ring-fencing as a replacement for transparency and market discipline.

The ring-fence will comprise deposits and overdrafts, leaving flexibility on other products, but Haldane said this "grey area" created perilous risks for regulators. 

"There is a case for moving the ring-fence outwards to mandate a broader set of activities that lie within," he said. 

Small business loans, trade finance and mortgages should be inside the ring-fenced arm which should have its own governance, risk management, balance sheet, treasury operations and even human resources to ensure the right culture, he said....

Anything that creates "perilous risks for regulators" by definition is an unacceptable risk for the financial system and therefore should not be part of financial reform.

I say this because the Great Recession showed that regulators are fallible and when they fail it comes at a huge cost to the taxpayer.

The Bank of England's new prudential regulation authority (PRA) ... will aim to move away from the "box ticking" approach of the past and be more judgement led in its approach which Haldane likened to a swat team pursuing "random sampling".... 

Many top banks were also unable to "simply add up the numbers" and calculate risks across the group, he added. 

The risk-based Basel rules forcing banks to hold more capital from January were also built on the "shakiest foundations". 

It would be a thankless task of deciding how much capital banks should hold against each asset, a game of "cat and mouse" that no regulator can win, Haldane said.

By requiring the banks to provide ultra transparency, financial regulators like the PRA can truly move away from a box ticking approach or engaging in no win games like determining capital adequacy.

With ultra transparency, the PRA can ask each bank's competitors and other market participants what they are most concerned about with that bank.  Asking this question harnesses the ability of the market to assess the banks and the risks they are taking.

Will Obama now bring transparency to all the opaque areas of finance created by Wall Street?

Having won re-election despite Wall Street's overt support of Mitt Romney, will President Obama now embrace bringing transparency to all the opaque corners of the financial system?

With any reflection, President Obama should realize that besides the Consumer Financial Protection Bureau and the Volcker Rule, Dodd-Frank is reform legislation written by and for Wall Street.  It substitutes complex rules/regulations and regulatory oversight, both of which can be gamed by Wall Street, for transparency and market discipline.

Clearly, this is unlikely to meaningfully change Wall Street in a positive manner.

The question is does President Obama want lack of meaningful reform of Wall Street as his legacy.

This question is also linked to his economic policies.  Does President Obama continue to pursue the Japanese Model for handling a bank solvency led financial crisis and protect bank book capital levels and banker bonuses at all cost or does he change and adopt the Swedish Model.

President Obama has 4 years of experience that shows that the US is no different than Japan when it comes to the Japan-style economic slump that results from adoption of the Japanese Model.

Simply put, even with an economy as big and robust as the US economy, the burden of the excess debt in the financial system is too great.  It diverts capital needed for reinvestment and growth to debt service with the result being a stagnant economy if not outright contraction.

President Obama can now chose to adopt the Swedish Model and require the banks to absorb upfront the losses on the excess debt.  This relieves the real economy of the burden of supporting this excess debt and results in the economy growing again.

The decision to adopt the Swedish Model is also a legacy issue.  Does President Obama want to be remembered for putting banker bonuses before the social safety net that protects and takes care of the elderly, the sick, the veterans and the poor?

At the same time, President Obama can also focus on bringing transparency back to all the opaque corners of the financial system.

For banks, he can push to have them required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

This has numerous benefits including unfreezing the interbank lending market, preventing future manipulation of interest rates like Libor, enforcing the Volcker Rule prohibition on proprietary trading and reducing in size if not breaking up the Too Big to Fail.

For structured finance securities ranging from covered bonds to securitizations, he can push to have them required to provide observable event based reporting of all activities like payments and delinquencies involving the underlying collateral before the beginning of the next business day.

This has numerous benefits including allowing investors to know what they own and allowing both Fannie Mae and Freddie Mac to be put into runoff mode as the private mortgage-backed finance market restarts.

Bringing transparency to all the opaque corners of the financial system is a conservative project

MIT Professor Simon Johnson wrote yet another column calling for the break up of the Too Big to Fail banks (his other topic is calling for banks to hold more capital).  What makes this column of interest is that it really makes the case for bringing transparency to all the opaque corners of the financial system.

The columnist George F. Will recently shocked his fellow conservatives by endorsing Richard Fisher, president of the Federal Reserve Bank of Dallas, to be Treasury secretary in a Mitt Romney administration. 

Fisher’s appeal, in Will’s eyes, is that he wants to break up the largest U.S. banks, arguing that this is essential to re- establish a free market for financial services. Big banks get big implicit government subsidies and this should stop. 

Will’s endorsement was on target: The true conservative agenda should be to take government out of banking by making all financial institutions small enough and simple enough to fail. As Will asks, “Should the government be complicit in protecting -- and by doing so, enlarging -- huge economic interests?”

Regular readers know that by failing to fulfill its responsibilities under the FDR Framework government is complicit in protecting the banks.

First, the government fails to ensure that market participants have access to all the useful, relevant information in an appropriate, timely manner so the market participants can independently assess this information and make a fully informed investment decision.

Second, the government offers its own opinion as to the risk of the banks.  Prior to the crisis, financial regulators talked about how risk in the banking system was reduced because of financial innovation.  After the start of the financial crisis, financial regulators talked about how the results of a stress test the regulators ran showed the banks were adequately capitalized.

But Will could have gone further -- much of what Fisher recommends also is appealing to people on the left of the political spectrum. ...

As is transparency and the government fulfilling its responsibilities under the FDR Framework.

Unfortunately, Fisher’s views on “too big to fail” banks draw the ire of powerful people on Wall Street,

Transparency draws the ire not just of powerful people on Wall Street, but also powerful people in Washington (transparency doesn't draw the ire of economists as they assume that it exists).

Unlike the breaking up the Too Big to Fail or higher capital requirements, transparency is a threat to the Blob (aka, politicians, financial regulators, Wall Street and their lobbyists).

As FDR understood, with transparency, the Blob's power is limited.  As a result, policies like adopting the Japanese Model for handling a bank solvency led financial crisis and protecting bank book capital levels and banker bonuses at all costs would not be adopted.

Fisher and Harvey Rosenblum, executive vice president and director of research at the Dallas Fed, have laid the groundwork for a comprehensive reassessment of finance and banking -- and the effects on monetary policy. 

The closest parallel is the rethink that happened during the 1930s, as the gold standard broke down and the world descended into depression followed by chaos. 

But their approach is also reminiscent of the way that monetary policy was reoriented in the early 1980s, as Fed Chairman Paul Volcker and others brought down inflation. 

The world and the U.S. economy have changed profoundly. We need to alter the way we think about the financial system and monetary policy.

Actually, with the FDR Framework, your humble blogger laid the groundwork for thinking about the financial system and monetary policy.

Fisher and Rosenblum have expressed, separately and together, three deep ideas since the financial crisis erupted in 2008. 

First, very large banks are too complex to manage. “Not just for top bank executives, but too complex as well for creditors and shareholders to exert market discipline,” they wrote in a Wall Street Journal op-ed in April. “And too big and complex for bank supervisors to exert regulatory discipline when internal management discipline and market discipline are lacking.” 

Complexity, they say, magnifies “the opportunities for opacity, obfuscation and mismanaged risk.”....

And here is where Fisher, Rosenblum and Mr. Johnson make the case for bringing transparency to all the opaque corners of the financial system.  For banks, transparency requires that they disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Everyone knows that transparency is needed if market participants are to independently assess the risk of an investment and exert market discipline.

Without it, market participants have to rely on a third party for a risk assessment if they are going to invest.  For banks, the third party relied on prior to the financial crisis was the financial regulators.  For structured finance securities, the third party relied on prior to the financial crisis was the rating agencies.

Clearly, both of these were discredited at the start of the crisis as their risk assessments were shown to be wrong.  With their stress tests, the financial regulators have confirmed that their risk assessments have not improved.

As Fisher, Rosenblum and Johnson point out, without this disclosure bankers use complexity, a form of opacity, to magnify the opportunities to profit from opacity, obfuscation and mismanaged risk.  Which further confirms Yves Smith observation on Naked Capitalism that nobody on Wall Street is paid to create low margin transparent products.

Second, too-big-to-fail banks do actually fail, in the sense that they require bailouts and other forms of government support. This is exactly what happened in the U.S. in 2007 through 2009, and it is what is occurring in Europe today....

Regular readers know that a modern financial system is designed so that banks do not require bailouts.

Banks have deposit guarantees and access to central bank funding and as a result, they can continue operating and supporting the real economy when they have low or negative book capital levels.  The deposit guarantee effectively makes the taxpayer the silent equity partner while the bank has low or negative book capital levels.

The reason behind the bailout was the fear of contagion.  One bank would fail and it would bring down the entire banking system.  Contagion only exists when the the government fails to ensure adequate transparency.

Regular readers know that with ultra transparency not only can market participants assess the risk of each bank, but they can adjust their exposure to each bank based on its risk and what the market participant can afford to lose given this risk.

This ends contagion and any excuse for bailing out the banks.

Also, please note that Professor Johnson explicitly says that what we have is a bank solvency led financial crisis as the 'too-big-to-fail banks do actually fail'.

Third, monetary policy cannot function properly when a country’s biggest banks are allowed to become too complex to manage and prone to failure. 

In “The Blob That Ate Monetary Policy,” a Wall Street Journal op-ed published in September 2009, Fisher and Rosenblum pointed out that cutting interest rates doesn’t work when systemically important banks are close to insolvency. The funding costs for banks go up, not down, as a crisis develops....

The funding costs for the banks went up because of opacity.  Specifically, that the banks are 'black boxes' and nobody knows what is hiding on and off their balance sheets.

As the Financial Crisis Inquiry Commission documented, banks with money to lend could not assess the solvency of the banks looking to borrow and therefore they did not lend (aka, the interbank lending market froze).

There is no mystery why the cost of funding went up.  It was the result of opacity.

“Well-capitalized banks can expand credit to the private sector in concert with monetary policy easing,” Rosenblum wrote with his colleagues Jessica J. Renier and Richard Alm in the Dallas Fed’s “Economic Letter” of April 2010. “Undercapitalized banks are in no position to lend money to the private sector, sapping the effectiveness of monetary policy.”

This is a prime example of not understanding that the origination of loans is separate from the funding of loans.  The reason these are separate is that funding for the loan can come from the bank's balance sheet or by distributing the loan through a bank syndicate or by sale of the loan to pension funds, insurance companies, hedge funds or through an asset-backed security.

In our current financial crisis, the reason that lending has slowed dramatically is that the banks were not required to recognize upfront the losses they will ultimately realize on their bad debt exposures.  Instead, the financial regulators adopted forbearance that allowed the banks to engage in 'extend and pretend' techniques that turned bad debt into 'zombie' loans.

The collateral tied up as security for these 'zombie' loans undermines the ability of banks to lend.

Recall that banks are senior secured lenders.  The collateral tied up in the 'zombie' loans artificially increases the value of collateral on new loans (if the collateral were not tied up, the market value of all the collateral would be lower - an example of this is residential and commercial real estate).

The problem for lenders is they know the value of the collateral should be lower, but they just don't know how much lower.  As a result, they are reluctant to make loans.

Time to rethink regulatory reform and replace it with ultra transparency

The American Banker ran an interesting article on all the complex rules that are being implemented as a result of the Dodd-Frank Act and Basel III and asking if there is a better solution.

Regular readers know that all these complex rules and increases in regulatory oversight are a substitute for the simple solution of transparency and market discipline.

As I have said numerous times, with the exception of the Consumer Financial Protection Bureau and the Volcker Rule, Dodd-Frank should be repealed.

It should be replaced with an Act that brings transparency to all the opaque corners of the financial system.  At a minimum, this Act should

• Require that banks provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  This is the data market participants need to independently assess the risk of the banks and exert discipline to restrain risk taking.

• Require that structured finance securities provide observable event based reporting on all activities like a payment or default involving the underlying collateral before the beginning of the next business day.  This is the data that investors need to know what they own.

Utilizing 21st century information technology, all of this disclosure can be centralized in the 'Mother of All Financial Databases' and made available to all market participants.

Market participants have an incentive to use this data because there is money to be made from using it.

• For example, banks with deposits to lend can use this data to assess the risk of banks looking to borrow.  With this assessment, the interbank lending market can reopen.

• For example, market participants can calculate Libor because they have access to all of the interbank transactions.

Regular readers know that unlike complex rules and regulatory oversight, transparency and market discipline have pass the test of time.

How ripe is the moment? Even lawmakers who voted for the 2010 reform law are open to improving it. 

"Congress never gets it right, when you're looking at massive reform legislation, the first time through," Sen. Mark Warner, D-Va., told The Hill newspaper last week. "You directionally head in an area and then you come back, two years, three years hence to do a corrections legislation."...

Ammunition for anyone seeking change arrived Monday from Karen Shaw Petrou of Federal Financial Analytics.... 

Her stark conclusion: even if regulators did everything called for in Dodd-Frank, and did it perfectly, financial services supervision would still be a mess. Throw Basel III in the mix and it just gets worse. 

The end-result of numerous agencies pumping out massive rules to meet statutory deadlines will be a tangle of contradictory mandates that will be tough to enforce and impossible to comply with....

Please re-read the highlighted text as Ms. Petrou makes the case for restarting financial reform with a simple focus on bringing transparency to all the opaque corners of the financial system.

As I have documented on this blog, simply bringing transparency back to the opaque corners of the financial system will go a long way towards fixing all of the problems that financial reform is suppose to address.

Transparency has one more advantage over loophole ridden complicated regulations that the industry will render irrelevant.  Transparency has been shown to prevent a financial crisis in the first place.  

Who should pay when a bank fails?

A Bloomberg article reports that the hold up in an EU-wide bank supervisor is answering the question of who should pay when a bank fails.

Regular readers know that the answer is different if banks are 'black boxes' or they are required to provide ultra transparency.

So long as disclosure by banks leaves them resembling 'black boxes', in the short term, the losses should be absorbed by the host country taxpayers.

However, if the banks are required to provide ultra transparency and disclose on an on-going basis their current global asset, liability and off-balance sheet exposure details, then the losses should be absorbed by the equity and unsecured debt holders.

Why the difference in who pays for the losses?

When bank disclosure leaves them resembling 'black boxes', investors cannot independently assess the risk of their investment.  As a result, they rely on the host country regulators' statements about the banks' financial condition.

This creates a moral obligation to bailout the investors as who are they to 'doubt' the regulators who have access to better information. [Announcing the results of stress tests in the absence of ultra transparency effectively commits the taxpayers to bailing out the investors.]

When banks are required to provide ultra transparency, investors are responsible under the principle of caveat emptor for all gains and losses.  As a result, they have an incentive to independently assess the risk of the banks.  Knowing they are on the hook for absorbing losses, investors will adjust their exposure to what they can afford to lose given the risk of each bank.

What happens if the losses on and off the banks' balance sheets overwhelm the capacity of the host country's taxpayers to absorb?

Fortunately, modern banking systems are designed to handle this problem.

Please recall that with deposit guarantees and access to central bank funding banks can continue to operate and support the real economy for years even if they have low or negative book capital levels.

It is this capacity to continue operating when a non-financial firm would be closed down that creates the opportunity to take the burden off of the host country taxpayers.  Instead of the taxpayers directly putting up the money, the money is put up through retention of future bank earnings.

This indirect way of paying for the losses reflects the simple fact that when banks have low or negative book capital levels the deposit guarantee effectively makes the taxpayers the bank's silent equity partner.

Retention of earnings is simply paying off the taxpayers' silent equity contribution.  This greatly reduces the upfront cost to taxpayers and greatly increases the resources available to absorb losses in the banking system.

But what about existing creditors and shareholders?

Existing creditors continue to be paid off.  Existing shareholders maintain their ownership interest.  However, it is likely to be several years before they see any dividends.

But given that the existing shareholders don't have access to ultra transparency, isn't it unfair to reduce the value of their investment?

No.  A shareholder would have to be clueless not to pick up a newspaper over the last 5 years and read about all the bad debt in the financial system.  They know with the lack of disclosure that they are blindly betting.

What about banks that cannot generate earnings after absorbing the losses on the bad debt they are exposed to?

These banks should be resolved.  Because of the moral obligation, at a minimum, retail investors should be made whole.

Underscoring concern in EU countries that don’t use the euro, Swedish Prime Minister Fredrik Reinfeldt said the bank plans are “complicated” and Sweden can’t be liable “for losses or problems in other countries’ banking systems.”

A French official, briefing reporters after a meeting between Hollande and Merkel, said agreements in principle were possible. He said Finland, Sweden and the U.K. were the biggest obstacles. 

With European officials saying no decisions are likely at the summit, the draft of the statement to be issued after the meeting sidesteps how the EU plans to backstop its financial system. It dropped a pledge made after their June gathering to break a cycle of banks and countries worsening each other’s woes. 

Leaders then in June made a calculated decision to start with unified bank oversight and discuss common cleanup costs later. Yet every element of the bank overhaul draws debate back to the fight over who should pay when a bank fails. 

Bank of England's Paul Tucker warns banks that worse yet to come

The Guardian reports that the Bank of England's Paul Tucker has warned banks that the worse is yet to come and that banks need to end their get-rich-quick culture.

The lead candidate to take over from Sir Mervyn King as governor of the Bank of England, Tucker told a City audience: "There is a tangible probability – not a high probability – that the worst may still be ahead" for banks, which was why they needed to hold more capital....

Regular readers know that your humble blogger feels sick every time I hear another economist or regulator call for banks to hold more capital.

Apparently the economist or regulator did not get the message from the OECD that bank capital is meaningless.

At the top of the list of reasons why it is meaningless is that regulators have engaged in regulatory forbearance which allows the banks to push off recognition of losses on bad debt through the use of extend and pretend.

Next on the list of reasons why bank capital is meaningless is that the accounting profession allowed banks to end mark-to-market accounting on all those toxic securities the banks are holding.  Since there is no deep, liquid market for those securities, nobody knows how much the current book value of these securities overstates what would be realized if the securities had to be sold.

Since losses haven't been realized, bank book capital is overstated.  Hence, it is meaningless.

"I would say that the Bank believes what it always believed: that sound and honest finance is not only essential for the economy, it will be good for the City too."

Regular readers know that at the heart of sound and honest finance is ultra transparency.  It is only when banks disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details that sound and honest finance occurs.

Without sunlight as the best disinfectant, we have ample evidence that bankers will engage in bad behavior (think Libor manipulation, interest rate swap mis-selling,....).

He said the Financial Policy Committee, on which he sits, was concerned a "tidal wave" could be coming. "We may all be grateful that there is a few billion more of capital here and there in the banking industry, keeping banks in the private sector rather than the dead hand of state ownership."...

Modern banking systems are designed not to require the 'dead hand of state ownership'.

Banks can operate and support the real economy for years even if they have low or negative book capital levels.  They can do so because of deposit guarantees and access to central bank funding.

With deposit guarantees, taxpayers are effectively the silent equity partner for the banks when they have low or negative book capital levels.

Tucker said bankers needed to be paid in subordinated debt and put more focus on customer service rather than sales and on the medium-term success of the firm. 

"Putting it bluntly that would make it less easy to get rich quick irrespective of the quality of the business transacted or the compliance culture in their part of the firm," Tucker said, indicating this would require changes to the codes on remuneration....

As I have repeatedly said, there are two problems with paying bankers with subordinated debt.

First, it takes the regulators' focus off of ensuring that banks provide ultra transparency.  With ultra transparency, the banks are subject to market discipline and as a result a restraint on their risk taking.

Second, this debt does not represent 95% of their compensation.  Bankers will receive other forms of compensation.  For example, bankers are likely to continue to receive stock options.  The reward from taking risk and boosting share price could easily offset the risk of loss on the subordinated debt.

Bottom line:  market discipline made possible by ultra transparency is superior at restraining bank risk taking than compensating using subordinated debt.

While changes are under way, Tucker said that all risk could not be avoided: "We need to find broadly the right balance between, on one hand, safety and, on the other hand, the contribution that sound and honest finance can make to economic prosperity. 

A balance that can only be achieved if banks are required to provide ultra transparency and the invisible hand of the market allowed to work properly.

"We may not be able to abolish the occasional waves of optimism that grip humanity and the tendency to excess when they set off. But we can and must dampen their effects on the financial system and economy. This must include changing the incentives that bankers face."

Without ultra transparency, the financial system is dramatically more unstable as it is dependent on the Financial Policy Committee to dampen the occasional wave of optimism or pessimism that grip humanity.

As the financial crisis showed, when there is a single point of failure in the system like dependence on regulators, the single point of failure will fail.

It is simply unacceptable to have a single point of failure in the financial system.  I am not advocating doing away with the Financial Policy Committee.  I am simply saying that the system needs ultra transparency so that the financial markets are not dependent on the FPC for stability.

Answering Sheila Bair's 5 questions on financial reform

In a Fortune article, Sheila Bair proposed 5 questions on financial reform that she felt were critical to preventing another financial crisis.

Your humble blogger though Ms. Bair deserves a response to her questions.

[N]either candidate's campaign script acknowledges the connection between our current economic woes and the financial crisis which caused them..... The reality is, without a stable financial system, neither of you will achieve the sustainable economic growth you promise. 

Here are five questions I would like you to answer. 

WILL YOU BREAK UP TOO BIG TO FAIL BANKS? Dodd-Frank, the financial reform law enacted in 2010, bans future bailouts of failing financial behemoths and requires instead that they be put into either bankruptcy or a government-run liquidation process. Dodd-Frank also requires big financial institutions to demonstrate that they can fail in bankruptcy without causing widespread damage to our financial system. If they cannot make this demonstration, the law authorizes, indeed requires the regulators and Secretary of the Treasury, to restructure them or break them up....

Yes, but rather than use regulators as proposed under Dodd-Frank to break up these banks I will use market discipline.

All banks will be required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, market participants can independently assess the risk of the banks.  With this assessment, market participants can adjust the amount and price of their exposure to the banks to reflect each bank's risk.

As the cost of funds to each big bank increases to reflect their risk, the banks will come under significant pressure to make themselves less risky.

The first part of the TBTF bank to go will be the 'casino'.  This will disappear because traders know if they have to report their positions to the market every day this allows market participants to engage in activities that will reduce the profitability of the traders' proprietary bets.

The second part of the TBTF bank to go will be all those subsidiaries that are not engaged in supporting the real economy, but rather exist to arbitrage some rule or regulation.

WILL YOU CAP THE ABILITY OF LARGE FINANCIAL INSTITUTIONS TO TAKE RISKS WITH BORROWED MONEY? Prior to the crisis, regulators let many large financial firms fund their operations increasingly with borrowed money. When the housing market turned and mortgage-related losses mounted, these institutions were unable to make good on their massive debt obligations. Indeed, leading up to the crisis, many large banks borrowed over $30 for very $1 put up by their shareholders. In contrast, banks which borrowed $12 or less to every $1 of shareholder equity generally remained healthy....

Yes, but rather than use complex regulations like capping leverage I will use market discipline to cap the risk taking by large financial institutions.

As discussed above, the banks will be required to provide ultra transparency.  As a result, their cost of funds will reflect their risk.

Higher risk banks will face a higher cost of funds than lower risk banks.  This acts as a restraint on bank risk taking.

To put teeth into this restraint, I would let investors know up front that under the FDR Framework, the government has fulfilled all of its responsibility by ensuring that they have access to all the useful, relevant information in an appropriate, timely manner so they can independently assess each bank and make a fully informed investment decision.

As a result, the investors is responsible under the principle of caveat emptor for all gains and losses.

Knowing that the government will not bail the banks out, investors will keep bank management on a short leash or at least make sure that they can afford to lose their exposure to the bank.

WILL YOU REQUIRE WALL STREET FIRMS AND OTHERS WHO "SECURITIZE" LOANS TO RETAIN PART OF THE RISK IF THOSE LOANS DEFAULT?  Securitization, or selling bonds to investors which are backed by pools of mortgages, played a key role in the run-up to the crisis. Mortgage brokers and lenders originated millions of toxic mortgages which Wall Street firms blindly snapped up and sold off to unsuspecting investors. Paid up front, without having to retain any of the risk if those mortgages went bad, the mortgage securitization industry had all the wrong incentives to produce as many toxic loans as possible. Indeed, they had a saying - IBG/YBG -- for I'll be gone, you'll be gone - leaving investors, homeowners, and the public suffering the repercussions when those loans started to default....

No, as risk retention violates both the disclosure and caveat emptor principles of the FDR Framework.

First, risk retention is substituting complex regulation for transparency.  Investors should be provided with observable event based information so that all activities like a payment or default that occur with the underlying collateral are reported before the beginning of the next business day.  With this information, investors can know what they own.

Second, risk retention is substituting the idea that the securities are safe because the issuer would not want to lose their money for investors doing their own independent assessment of the securities.  Investors at all times are responsible for all gains and losses.

Finally, the investors' ability to enforce their rights under representations and warranties needs to be enhanced.  One way to do this is by providing observable event based reporting.  With observable event based reporting, the collateral can constantly be monitored for rep and warranty violations.

WILL YOU END SPECULATION IN THE CREDIT DERIVATIVES MARKETS? Many people rightfully point to bad mortgage lending as a key driver of the crisis.  Yet, hundreds of billions of mortgage losses by themselves would not have caused the crisis. The problem was the trillions of dollars of additional losses that were incurred world-wide by financial institutions who had made wrong-way bets on the performance of mortgage-backed bonds (and trillions of gains for the speculators who bet against them). Credit default swaps or "CDS" were the weapons of this mass destruction. Those who want to buy insurance protection against losses on bonds should be required to actually own those bonds, just as those who buy fire protection on a house need to actually own it. Will you require such an "insurable interest" for those buying CDS protection? Such a requirement would limit the size of this radioactive market and remove perverse economic incentives for speculators to benefit when bonds default. 

Yes, but rather than using complex regulations to ban trading in CDS I will use market discipline to ensure that when it comes to the banks they actually have the offsetting exposure.

This is easy to do because the banks will be providing ultra transparency.  A program like IBM's Watson can be trained to look across all the bank's exposures to see if the bank is blindly betting in the CDS market or has an offsetting exposure.

WILL YOU END THE REVOLVING DOOR? The spectacle of senior regulators moving into and out of industry has undermined public confidence in our regulatory system. Will you commit to appointing individuals at the Treasury Department and regulatory agencies who will be independent and promise never to work for the industry they regulate? People who want to use regulatory positions as stepping stones to more lucrative employment in the private sector have no place in government.

No.  While I strongly agree with what you have said, I would lose out on being able to attract people like yourself.

The only requirement I make of political appointees is that they adhere to making sure the FDR Framework is implemented in all the opaque corners of the financial system.  By definition this means that they will not substitute complex rules and regulatory oversight for transparency and market discipline.

Finally, one of the reasons that I am pushing that banks be required to provide ultra transparency is that it allows market participants to also monitor the bank regulators and their performance.  Ultra transparency not only brings market discipline to the banks, but also to their regulators.

BoE's Robert Jenkins says Investors must break their silence on financial reform

In an extraordinary speech, the Bank of England's Robert Jenkins called on investment fund managers to break their 'silence' on financial reform and to 'speak up' as they were needed to 'counterbalance the banks' otherwise the result of financial reform would be an even 'weaker system' than we have now.

For confirmation, just look at the US which passed the Dodd-Frank Act.  An Act written by and for Wall Street.

The Blob (aka politicians, financial regulators, banks and their lobbyists) used the momentum for reform after the financial crisis to substitute complex rules and regulatory supervision for transparency and market discipline.  In doing so, the Blob systematically weakened the financial system in the US.

Mr. Jenkins is warning that the same result could occur in the UK.

Fund managers have been accused of being “silent” and risked being seen as little different from investment bankers, in a warning from a top Bank of England policymaker. 

Robert Jenkins, a member of the Bank’s Financial Policy Committee (FPC), told an audience of senior fund managers that they had to “speak up” on bank reform or miss out on the “debate of a lifetime”. 

“You are the missing piece. What stakeholder group other than the investment management industry has the combination of financial expertise, credibility and clout sufficient to counterbalance the banks and so better shape the outcome of the debate? None. Also, no stakeholder group has been more silent,” said Mr Jenkins. 

In calling for the investors to counterbalance the banks, Mr. Jenkins is explicitly acknowledging that financial regulators are predisposed to favor the banks so as to avoid pushback from politicians.

This is a very important observation as under the FDR Framework, on which every developed country's financial system is based, financial regulators are suppose to be a counterbalance to Wall Street and the City.

Specifically, they are suppose to ensure that market participants have access to all the useful, relevant information in an appropriate, timely manner so that the market participants can independently assess any investment and make a fully informed investment decision.

Regular readers know that financial regulators failed to act as a counterbalance that ensured transparency and the result was a financial crisis.  Regulators let huge swaths of the financial system become opaque including 'black box' banks and 'brown paper bag' structured finance securities.

Now, the question is how to reform the financial system and return it to is roots in the philosophy of disclosure.

To do this requires talking not to Wall Street, the City and their army of lobbyists, but rather talking to the investors and the investors only!

The former City financier warned fund managers they risked being seen as little different from investment bankers if they continued to keep quiet on how to shape the finance industry. 

“At the end of the day you are guilty by association. You are members of the financial sector and the financial sector has wrought much damage. Bankers, money managers and, yes, financial regulators as well - in the eyes of the public we are all investment bankers now,” he said.... 

Mr. Jenkins correctly identifies the guilt of the money managers.

Recall how few lawsuits money managers filed against Wall Street and the City when it was clear that the investors whose money they lost suffered a loss as a result of illegal behavior.  For example, where are all the lawsuits related to Libor interest rate manipulation?

He warned that unless more investors spoke out on reform they would allow “the old financial structure” to be replaced by an even weaker system. 

“Its foundation is flawed, the walls are thin and the beams are brittle. You did not design it. You are not building it. But you and your clients will have to live in it,” he said.

Please re-read the highlighted text again as Mr. Jenkins is clearly saying that the UK is likely to repeat the US experience and pass the equivalent of Dodd-Frank that will systematically weaken the UK financial system.

Call this a race to being as investor unfriendly as possible.  A race that the US is currently leading with Dodd-Frank.

A race that no country can afford to win as it places maximum taxpayer money at risk for little in the way of benefit to the winning country.

Mr Jenkins comments come at a time of sweeping changes to financial regulation, as the Government prepares to push through new legislation governing the way banks and other financial firms can do business.

So far, the UK legislative and regulatory push is playing out just like Dodd-Frank.  Yes, I know that the UK substitutes ring-fencing for the Volcker Rule, but in the absence of requiring banks to provide ultra transparency both are fundamentally flawed and neither will reduce risk in the financial system or reduce the probability of the next bank bailout.

The question is will investors remind politicians and financial regulators that they expect transparency to be brought to all the opaque corners of the financial system and that financial regulators should be held responsible for insisting on the maximum amount of disclosure (it is the investors' decision what data being disclosed they want to look at)?

Despite taxpayer ownership, RBS still 'poster child for what went wrong in banking' and not example of how banks should operate

Stephen Hester, the CEO of RBS, acknowledges that RBS is still the "poster child for what went wrong in banking."

What UK taxpayers should find distressing about that statement is the simple fact that he then did not say RBS has become the model for what a 21st century bank should be.

Specifically, a 21st century bank understands that if customers are going to trust it, it must go above and beyond to show that it is trustworthy.

Regular readers know that this involves providing ultra transparency and disclosing on an ongoing basis its current global asset, liability and off-balance sheet exposure details.  It is only with level of disclosure that sunlight acts as a disinfectant for bad behavior.

With this level of disclosure comes a different culture.  A culture where all the useful, relevant information in an appropriate, timely manner is disclosed to customers.

I have always wondered why RBS is not the first global bank to provide ultra transparency.  What do they have to hide?  What are they afraid of?  A bank run?  The government already owns 82% of them.

In a speech to students and staff at the London School of Economics, Mr Hester said: “The banking industry in the decade preceding the crisis was focused on income, it expanded too fast, prioritised sales over service and failed to properly balance the interests of its customers and shareholders with those of its managers.” 

To this list I might add the Yves Smith observation, nobody was rewarded in the banking industry for creating transparent, low margin products.  Instead they were rewarded for creating opaque, high margin products where the high margins were available only because opacity prevented the customer from having all the useful, relevant information in an appropriate, timely manner to properly assess the risk of the product.

The banking veteran said RBS was resting on a “wafer thin capital base” before its collapse and had “effectively run out of money to fund itself and its customers”. 

In a speech that promised to speak “candidly” about his task of saving a failed bank and the transformation of the banking sector more generally, Mr Hester said the industry needed to make a “new compact” with society, where customer service comes first. 

Mr Hester said RBS, which is 82pc owned by the British taxpayer, had already made progress towards this goal, including reforming staff pay such as paying bonuses in shares instead of cash. 

But he said that pay reform “has to go further” to take account of customer service as well as sales.

The banking industry needs a renewal of the "old compact" with society where it is there to support society's needs for credit and payment services.

The 51 year-old said RBS had about 15 months of “heavy lifting” to complete in order to stand by its five-year recovery plan, although he warned the bank was not “out of the woods” as the bank still depended on the health of the economy.

My question is just how much more in the way of 'bad' assets is hidden on the RBS balance sheet?

Referring to the wider reform of the banking industry, Mr Hester said change was necessary but called current levels of public hostility towards bankers “particularly unhealthy”. 

He said the “many scandals” that have hit banking in recent years, such as the Libor-fixing scandal, were not unique problems. “I think it’s more accurate to say that most of them are related to one big scandal: banks have simply not been good enough servants of their customers in the recent past,” he said.

Actually, all of the scandals are related to the same big scandal.  Banks, with the regulators' blessing, have been able to create opacity in wide swaths of the global financial system.  Behind the veil of opacity bankers have been able to engage in bad behavior.

Libor is a classic example.  It was designed on day one to allow banks to manipulate the rate without market participants being able to see what was happening or regulators taking any action to stop it.

Repost: The Future of Finance: The end of opacity and the Mother of all financial databases

This post originally appeared on November 22, 2010.  Bloomberg's Jonathan Weil linked to it (see: markets) in his column on Sheila Bair's new book when he concluded

So let’s eliminate the secrecy. It damages our economy, undermines investor confidence and gives financial institutions too much leeway to go astray. 

Regulators haven’t shown themselves to be any better than the markets are when it comes to uncovering big problems at federally insured banks. We might as well make all their examination findings open records. That way, the public can see when the regulators are failing at their jobs. Depositors can make fully informed choices about where to keep their money. And banks will be under much greater pressure to fix their problems.

The post

The future of finance is the elimination of opacity throughout the financial system by using 21st century information technology.

This statement is the logical conclusion of the Bank of England's plan to substitute market discipline for bank examination.

As discussed in an earlier post, Bank of England Adopting 21st Century Oversight of Financial Institutions,  the current model of bank examination does not work.

The current bank examination model, as practiced by regulators like the Financial Services Authority and Federal Reserve, involves sending out large numbers of examiners to look through the banks' books, demanding lots of detailed information for their internal review and asking the banks to run stress tests on assumptions the regulators provide.  A key feature of this model is that no detailed information is shared with the markets.

If this model looks like it parallels how the rating agencies operate, it does.

The parallel in the US goes all the way to the issuance of a CAMELS rating by the regulator.  A CAMELS rating is for regulators eyes only and is a reflection of a bank's overall condition in the areas of capital adequacy (C), asset quality (A), management (M), earnings (E), liquidity (L) and sensitivity to market risk (S).

Just like the ratings produced by the rating agencies, since the markets do not have the information to do their own homework, the markets have to trust that the regulators get their ratings right.

Unfortunately, recent history shows that regulators were just like the rating agencies and they did not always get their ratings right.

According to a WSJ article,

a top Bank of England official, Andy Haldane, said the new regulator will curtail the FSA's practice of dispatching dozens of examiners to banks to collect loads of granular information... Mr. Haldane noted that ... they rarely yield much useful information for regulators, who can find themselves overwhelmed by the quantity of data."

Mr. Haldane identified the flaw in the bank examination model and the reason that regulators need to have banks disclose more information to the markets.

The markets are not overwhelmed by the quantity of data disclosed by financial institutions.  There are a number of market participants who are able to and have an incentive to analyze all of the individual asset level data these institutions could provide and turn it into useful information.

Andrew Redleaf, a hedge fund manager, takes the idea of banks disclosing data and market participants using this data further.  

He wrote

the late crisis happened not because banks were reckless or regulators incompetent, though both were surely true. It happened because together banks and regulators forged a system that denied citizens and markets the information they needed to respond rationally to events.

Banking has always been too secretive in this country. Banks are quasi-public institutions, performing both private and public functions, including sustaining the credit system that sustains the dollar itself. In return, the big banks especially are granted extraordinary privileges, such as the right to borrow from the Fed virtually for free at times of crisis. 

Under the circumstances there is no excuse for bank balance sheets to be anything but utterly transparent to the citizens and investors.... 

Imagine for a moment that in 2004 the government had required every major financial institution in the U.S., any one with the potential for imperiling credit markets, to publish their investment positions. All of them. In detail. Lists of every security or derivative held in their portfolios, along with all data about the underlying mortgage pools, defaults so far, etc.

With such a rule in place, the mortgage crisis likely would never have happened on the scale it did. Most of the worst mortgages, the loans that crashed the system, were written from 2005 through the early days of 2007. Opening the banks' books would have revealed just how near the edge they were playing. 

The resulting market pressure on bank securities would have forced them to cut back their mortgage books. This would have been a crisis of a sort; the housing bubble would have popped. But popping the bubble two years earlier would have avoided the worst of the damage.

Even if transparency failed to avoid the mortgage crisis, it almost certainly would have prevented the banking crisis and the crash of 2008. Because we would have known. 

We would have known how much -- or how little -- trouble Bear was in long before March 2008. We would have known, for better or worse, about Lehman, and Morgan, and Goldman, and Citi. Not instantly. 

It would take time to digest millions of lines of information kept secret for decades. But surely millions of investors poring over the information, including those heroic rag-pickers, of capitalism the vultures and short-sellers would have given us a quicker and better answer than the grand-high-poo-bahs.

The megabanks would hate it....They would scream bloody murder about being forced to let competitors see what they owned. Nonsense. 

Investors who hold interesting or unusual positions in their portfolios may have something to lose by disclosure. But too-big-to-fail banks have no business taking "interesting" positions. Banks are not supposed to be extra clever, they are supposed to be extra careful."

On February 23, 2009, in a Wired article, Daniel Roth provided the support for Mr. Haldane's observation and solution in much more detail.  

"Even the regulators can't keep up. A Senate study in 2002 found that the SEC had managed to fully review just 16 percent of the nearly 15,000 annual reports that companies submitted in the previous fiscal year; the recently disgraced Enron hadn't been reviewed in a decade. 

We shouldn't be surprised. While the SEC is staffed by a relatively small group of poorly compensated financial cops, Wall Street bankers get paid millions to create new and ever more complicated investment products. By the time regulators get a handle on one investment class, a slew of new ones have been created. 

'This is a cycle that goes on and on—and will continue to get repeated,' says Peter Wysocki, a professor at the MIT Sloan School of Management. 'You can't just make new regulations about the next innovation in financial misreporting.' 

That's why it's not enough to simply give the SEC—or any of its sister regulators—more authority; we need to rethink our entire philosophy of regulation. 

Instead of assigning oversight responsibility to a finite group of bureaucrats, we should enable every investor to act as a citizen-regulator. We should tap into the massive parallel processing power of people around the world by giving everyone the tools to track, analyze, and publicize financial machinations. 

The result would be a wave of decentralized innovation that can keep pace with Wall Street and allow the market to regulate itself—naturally punishing companies and investments that don't measure up—more efficiently than the regulators ever could.

Tracking Wall Street's complex inventions may be difficult for regulators, but it's a snap given the right software.... 

When data is kept under lock and key, as mysterious as a temple secret, only the priests can read and interpret it. But place it in the public domain and suddenly it takes on new life. People start playing with the information, reaching strange new conclusions or raising questions that no one else would think to ask. It is impossible to predict who will become obsessed with the data or why—but someone will. 

'People care about money,' Tim Bray, director of Web technologies at Sun Microsystems says. 'There's money in money and substantial personal upside to someone who can mine the data and uncover the truth.'"

How can the disclosure pushed by regulators like Haldane and investors like Redleaf actually be implemented?

By creating the "mother of all financial databases."  This is the database that your humble blogger has been pushing since before the credit crisis (here, here and here) and is necessary if European investors are going to be able to comply with the 'know what you own" provision of Article 122a of the European Capital Requirements Directive.  

This is the database that the Office of Financial Research and Data (OFR) is suppose to develop, but because it is a governmental entity never will.  OFR is fundamentally handicapped because:

1. The current operating philosophy of the regulators is not to share detailed information with the market.  
2. By law it must, where possible, use information collected by other governmental agencies.  What if the frequency that another governmental agencies collects data, say monthly, is not what is required to, as Lloyd Blankfein advised, monitor every position every day?

What is required is an independent third party to run the mother of all financial databases.  The independent third party must only be in the business of managing this database.  This assures all market participants that the database is free of all conflicts of interest and they can trust the numbers.