Nov 19

Transparency: The Lubricant for Loosening the Grip of Fear


Markets are notorious for moving between the states of fear and greed.  For a number of years, we were living within the greed state.  Low corporate bond spreads…no problem.  Low credit capability for mortgage borrowers…no problem.  The great amounts of liquidity in the global financial markets assured that more dollars would be chasing financial assets, looking for a home, any home, even a subprime home, that could provide a yield or return of some kind.

However, first the bond market and now the equity market have shifted gears to the state of fear.  The US economy is slowing and may move into recession by the end of next year.  The equity markets await the salve of Fed easing, but Mr. Bernanke must be careful not to tip his hand, lest the dollar will fall swifter than few of us can imagine.  Any corner of the financial or real economy subject to the use of credit has been and will continue to be impacted by what we called over a year ago “Deleveraging”.  (Those that simply refer to this as a credit crunch are missing the fact that financial institutions will probably be forced to delever to some degree to meet their capital requirements; while we have already seen this occuring in other areas like hedge funds.)

What can be done to alleviate the grip of fear?  Let’s start by getting at the truth.  It may not set us free, but it sure would give us all a better idea of how pervasive subprime and other credit related problems are.

What if, instead of, slowly leaking out credit related write downs, banks and brokerages actually had to list the securities subject to write down? 

Transparency in our time. 


Not really.  Here in the world of US insurance companies, annual statement filings must list all investment holdings along with significant data, including cusip, book value, market value, yield, credit rating, etc.  Quarterly, insurers file statements that include their investment transactions.  And the NAIC (National Association of Insurance Commissioners) is even considering going further with a proposal to add an annual statement disclosure outlining all subprime exposure (direct and indirect), including MBS, CDO’s, other structured securities, debt and equity securities of companies with ‘signficant subprime exposure’, and the always perplexing ‘other assets’.

Of course, banks and brokerages would complain mightily about this proposal.  However, I am only suggesting detail on securities subject to write down.  Why shouldn’t we know how problemmatical these holdings are and how they are being valued?

Would it be a violation of trade secrets or trading strategies?  No, because such disclosure would only apply to a portion of the overall investment portfolio.  And, I’m not sure what partial disclosure of a portfolio really tells us about overall strategy.

Would it let others know what they might be trying to ‘unload’ in the future?  Possibly, but once the securities are written down, the rush to unload may not be so great as the ‘pain’ should already be felt.

Or, would it allow banks and brokerages to hide the extent of the ‘damage’ from bad investment decisions, hoping markets would reverse before they have to revise their write downs at a later date?  Such banks are acting like the two year old boy who doesn’t want to tell his parents he unloaded in his pants…until he positively had to do so.

We’ve read talk of a ‘super’ regulator being established with authority to require such disclosures.  However, I believe that existing regulators have the ability to do so (and the last thing we need is another regulatory bureaucracy).  In the US, the SEC, promoters of the ‘disclose but caveat emptor’ approach to regulation, should require this transparency.

The accountants are indeed trying sometimes, but they are trying to be quasi-regulator (tough to do when the institutions ‘quasi-regulated’ pay your audit fees) by forcing public companies to show how they obtain valuations on securities and allowing them to choose mark to market.

Please, no new regulator, just a requirement for transparency.  Once we know how bad these credit related problems, the market will swiftly adjust.  And, like members of Alcoholics Anonymous, the banks and brokerage firms, after admitting they have a problem and how large it is, can begin taking steps to improve.

Transparency is the lubricant that can loosen the grip of fear in the markets.  The tools are there.  We only have to use them.