It's Not Liquidity Or Solvency That's The Problem: It's Transparency

from the a-lack-of-information dept

Tue, Dec 2nd 2008 11:40am — Mike Masnick

Last month, in writing about the financial crisis, I tried walking through the root causes of how the financial crisis happened and how to prevent it from happening again -- and the point I kept coming back to was the lack of transparency. It wasn't (as some people want to claim) "greed" or a "lack of regulation" that caused the problem, but bad information (though, some might blame that on greed and a lack of regulation). Aaron deOliveira points out that some folks are noticing the same thing, suggesting that the real problem these days isn't a lack of liquidity in the markets, but a significant lack in reliable information. People just don't know how much things are worth, and that's a huge problem.

Last week, on the always excellent Planet Money podcast, there was a discussion about what money really is. Many people think that it's a hard representation of value, but it's not. As the podcast noted, money is a relationship. Take a listen to fully understand what this means, but it's exactly right. Money is merely a relationship of trust between certain parties that enables trade. If I trust this piece of paper is worth a certain amount, I can do business with you. If I don't trust that the paper or trinket you hand me is actually worth anything, then I will not do business with you, and your "money" is not money at all.

The problem that we're experiencing today is that, due to a lack of clear and trustworthy information out there, no one is quite sure what anything is worth, and that makes any sort of trade difficult. Money only works when there's a trusting relationship, and you only get that sort of trusting relationship when there is a reasonable flow of information to the parties involved, such that they're confident that what they have (or what they're trading for) has value. The problem over the last few months (or, for some, years) is this realization that the information they had was bad, and they could not trust it, and thus, the "relationship" that made thing valuable disappeared. Without this trust, plenty of things that do have value are being severely undervalued, because there's no (or very little) credible information, and that's leading to panic, because no one is sure what anything might actually be worth.

So, once again, we're back to the situation where we were before: the answer should be more information, more widely distributed in a much more open fashion. We should all be demanding significantly more transparency both from corporations on any sort of investment they put forth as well as from the government who is shoveling dollars -- but not information -- into the market to try to deal with the problem. But, until it gets more information into the market, then the trust will not be regained, and the dollars they throw into the market will merely decrease in value, because there are not enough relationships built on trustworthy information.

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Filed Under: financial crisis, information, transparency

37 Comments

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Anonymous Coward, 2 Dec 2008 @ 12:04pm

With full transparency, how will the last sucker be found?

Did anyone every stop to wonder why stocks have any value at all? I mean they pay $1 dividend on a $70 stock thus giving a whopping 1.4% return! So why is the stock worth $70 with such a measly return? Oh, because it might go up to $80. But then it would have a 1.25% return! So as the price goes up, my return goes down? Huh!? But wait, the company will make record profits this year so the price of the stock will go up! But wait, I will probably only get a few more pennies of dividend for this record profit so why is the price going up again? Gambling plain and simple.

If stock prices were based on anything real, such as the dividend, there would be no wild swings in the markets. But since most of the stock price is based on the gamble the next sucker will pay more for it than I did, it can swing wildly when lots of suckers enter or exit the market.
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Anonymous Coward, 2 Dec 2008 @ 12:06pm

Re:
In addition, we have the huge executive salaries because the link between stock price and dividend has been broken. That means executives can take as much as they want and stock price won't be affected much at all.
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Anonymous Coward, 2 Dec 2008 @ 12:07pm

Correct.
Great article, Mike.

Spoken like a true genius.
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Dave (profile), 2 Dec 2008 @ 12:32pm

XML for financial derivatives
One way to deal with the transparency problem - XML for financial derivatives.

Make issuers fully describe their offerings in machine-readable form - all the way down to the individual borrowers or assets.

See this blog posting for a fuller discussion.
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Anonymous Coward, 2 Dec 2008 @ 12:38pm

"It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning." -- Henry Ford
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Skeptical Cynic (profile), 2 Dec 2008 @ 12:48pm

Good Piece!
The truth is that anyone that has some financial knowledge knew this a long time ago. If I don't know what you have is worth the money I am going to loan you for it then I am not going to loan to the money.
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the_dukeman (profile), 2 Dec 2008 @ 12:49pm

false value is a real issue
The false valuation of real estate has been quite a large contribution to this and previous large Wall ST dives. This problem evidenced itself in the late '70s and spread like wildfire. Prior to that era, real estate values, especially private homes, rose at a more stable rate overall, generally not by great leaps and bounds. These inflated values created the need for much more financing, which in turn fueled further inflation which could be sustained by the huge rise in the use of credit. People will always pay more for something if they can borrow for it. A domino effect followed. Of course the dominos must fall at some point. Even now the real estate values will be propped up by the government in an effort to recoup the bailout investment, instead of letting them adjust to the proper price point (in my estimate a drop of 70%). This is exactly what happened with the 80's bailout and is a major contribution to the current situation. A price adjustment such as this won't be popular (will we never learn?), but would provide a much more stable platform for real estate investment. Right now is the perfect time for this price adjustment to occur.
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Skeptical Cynic (profile), 2 Dec 2008 @ 12:51pm

Re:
That quote still stands today. Most people can not understand that after the dollar was taken off the gold standard it's value has always been based on the "Good Faith and Credit" of the US government. And if then understood that in it's truest sense then money (all money) would not be worth the paper it's printed on because they could not understand that concept or it's value.
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the_dukeman (profile), 2 Dec 2008 @ 12:56pm

Re: Good Piece!
That's exactly how the credit problem escalated. Inflated real estate prices fueled a credit frenzy. As long as the prices were kept inflated, there was plenty of "collateral".
Reminds me of a feedback loop at the last concert I attended. Ouch, my ears!
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Anonymous Coward, 2 Dec 2008 @ 1:03pm

Re:
Transparency still can't tell the future, there will always be a gamble...
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Stephen, 2 Dec 2008 @ 1:06pm

What really backs currency
The article is correct in that there is an aspect of trust that enters into the value equation as it relates to money. But money (dollars specifically) derives it's real value from the fact that it is a store of debt. Every dollar comes into existence through some kind of exchange for a less liquid form of debt (i.e. Treasury bills) or some other kind of valuable collateral. Value is upheld through the actions of tax collection enforcement, laws that give it legal tender status, anti-counterfeiting measures, and (importantly) a trust that the gov't will not debase the currency by simply printing more of it in the absence of some type of collateral with which to exchange the the newly printed money. The real problem we now face is that the quality of the collateral the FED is accepting has dropped significantly (and they have refused to reveal exactly what all that collateral really is). If that collateral loses its value, then we are effectively turning on the printing presses. The real solution to these problems is to stimulate economic growth in the real economy rather than engage in the futile attempt to do it artificially through monetary policy.
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Lawrence D'Oliveiro, 2 Dec 2008 @ 1:21pm

Quantity vs Quality
The problem has never been lack of information, the problem has always been lack of trustworthy information.

I have a feeling that all these demands for “greater transparency” will end up being trivially satisfied by deluging everybody with a flood of reports and updates and blog postings and things that don’t leave anybody the wiser.
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bowerbird, 2 Dec 2008 @ 1:28pm

> It wasn't (as some people want to claim)
> "greed" or a "lack of regulation" that
> caused the problem, but bad information
> (though, some might blame that
> on greed and a lack of regulation).

um, it _was_ greed.

and the "bad" information was "bad" because
the greedy people willingly closed their eyes.

they _knew_ those home prices were inflated.

they _knew_ the people who got the loans that
they were giving out couldn't afford to repay 'em.

they _knew_ those "variable rate mortgages" were
time-bombs that would be exploding down the line.

they _knew_ all of that, and yet they continued with
their "business as usual" approach because they are
greedy, and their business was making them rich...

so as long as they could package up these bad loans
and sell them off to each other, buy them back, and
sell them off again -- each time at a price that was
even more inflated -- they were happy to do that...
and why not? they extracted a "profit" every time!

so they did it to the point that the imaginary value
of those packages exceeded their _actual_ value by
_hundreds_of_billions_of_dollars_. nearly a trillion.

and they knew they could do it because they knew
that _we_ would suffer (from loss of our pensions)
before _they_ would suffer. (they still have all the
money they extracted with their criminal scheme.
and now they're in line for public money as well!)

this isn't new, either. it's essentially an update of
the savings-and-loan scandal of just 20 years ago.

this wasn't an accident, or just "bad" information.
it was a willful theft from the public treasury, and
the only reason it came down when it did, and as
quickly as it did, is because the perpetrators knew
that barack obama would blow the whistle on their
bullshit.

-bowerbird
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micmac, 2 Dec 2008 @ 1:34pm

re: false value is a real issue
If most residential real estate were truly worth 70% less than the prices of 2 years ago, the problems we face are probably insurmountable. In Denver, a house that would cost $125,000 to build (not counting land costs), was selling for about $250,000. That was probably much too high, but if the real value was only 30% of that, then the house could not have been built. I find it hard to believe that houses should be selling for significantly less than replacement costs.
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BullJustin (profile), 2 Dec 2008 @ 1:44pm

Great Points
Transparency may be the biggest issue, but our current opacity is more a symptom of a failing system than the root cause. Forcing transparency on companies would greatly help, but it won't solve the problem. The problem is still rooted in individual greed and laziness, and no amount of transparency will solve those social ills.

A complete overhaul of our social, educational, commercial, governmental, and religious institutions is the only thing that can save us.
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Anonymous Coward, 2 Dec 2008 @ 1:53pm

Sounds like a long blurp that boils down to greed. Relationship my arse. Give me a f*cking break.

Stop explaining a start rolling people in tar and feathers like the good old days. You know, back when America wasn't a country of turds.
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Mogilny, 2 Dec 2008 @ 1:57pm

Information is only good if we use it
Even if information is made available, i do not think it will make a difference if there is no regulation that leverages it. You don't think that these banks checked how deep the pool was before they took a dip? They knew the risks, no doubt.
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Mogilny, 2 Dec 2008 @ 1:57pm

Information is only good if we use it
Even if information is made available, i do not think it will make a difference if there is no regulation that leverages it. You don't think that these banks checked how deep the pool was before they took a dip? They knew the risks, no doubt.
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Urban, 2 Dec 2008 @ 1:59pm

Re:
Thank you.
Now we need the other 299,999,999 people to get their heads out of their rectums.
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Mogilny, 2 Dec 2008 @ 2:03pm

Ooops
Sorry for the double comment. I would like to add that the average folk don't really care about information. They wouldn't mind playing sheep as long as they are promised a greener pasture ahead.

A bit off topic, information can also be used as a tool of manipulation. The government has being dicking with the markets with 'information'. Higher than expected GDP estimates (that was down graded 2 weeks later), or the 'start' date of the recession is kicked back to dec. 2007 when they have been in denial for most of 2008. are examples of how the government uses information to manipulate market confidence.
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Bradley Stewart, 2 Dec 2008 @ 2:27pm

NOW YOU SEE IT AND NOW YOU DON'T
About seven years ago I was visiting my dieing father in the hospital. It's funny the things that one speaks about at a moment like this. For many years he was a Stock Broker by trade and a very conservative invester. I asked him if he ever bought any Enron stock for either himself or his clients. He told me that he did not. I asked him why? He explained to me that as hard as he tried that he just could't understand their financial statements.
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jonnyq, 2 Dec 2008 @ 2:34pm

Re: Re:
Hope there wasn't anything useful in that comment. If someone thinks they have to press "enter" at the end of every line, then I assume their comments are too dumb to read. Hope I'm not missing anything.
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Urban, 2 Dec 2008 @ 2:38pm

Re: Re: Re:
Now we are counting on the remaining 299,999,998 to come through!
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Mogilny, 2 Dec 2008 @ 2:49pm

Re: Re: Re:
Haha. He could be on a mobile. Maybe a blackberry?
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mslade, 2 Dec 2008 @ 2:50pm

Err??
I agree that transparency is good and necessary. But saying it's the REAL cause of all of this, as opposed to "greed" and "lack of regulation" (none of these are mutually exclusive) is way way way over-simplifying.

I think what you meant to say was that transparency is one of the factors for which there is a realistic goal. You can't defeat greed, and regulation isn't really necessary if things are truly transparent.
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josh, 2 Dec 2008 @ 2:57pm

greed & degregulation are at the root
More transparency would have helped avoid or lessen the crisis, but you are fundamental wrong to say that lack of transparency was the cause. The lack of transparency stems from the root cause of the crisis: greedy people hiding and manipulating information and deregulation allowing it to happen.
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the_dukeman (profile), 2 Dec 2008 @ 3:27pm

Re: re: false value is a real issue
The replacement costs are high as a trickle down effect. Inflation across the board has been fed by the fact that people have had to raise the price of practically everything that could be sold so they can afford to pay their mortgages. This also contributed to the dollar losing strength around the world. The 70% estimate is based on the dollar staying strong in the world market and real estate prices progressing at a more steady rate. The two highest priced items in an average family's budget are mortgage and car payment. Automobile prices are also much higher priced than they should be, but this relates more directly to the trickle down effect of the real estate price glut.
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bowerbird, 2 Dec 2008 @ 4:18pm

you assume
i don't think i "have to" press the enter key at the end of every line.
i do it because i _want_to_ control my linebreaks. i also don't care
whether you -- or anyone -- wants to read my comments or not...

-bowerbird
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Mike (profile), 2 Dec 2008 @ 4:41pm

Re: greed & degregulation are at the root
More transparency would have helped avoid or lessen the crisis, but you are fundamental wrong to say that lack of transparency was the cause. The lack of transparency stems from the root cause of the crisis: greedy people hiding and manipulating information and deregulation allowing it to happen.

I disagree. The amount of greedy people in the world hasn't changed, and this impacted a lot more than greedy people. The *problem* was the lack of transparency made it so the non-greedy people were convinced they were investing in non-risky assets, when the reality was quite different.
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Pops, 3 Dec 2008 @ 4:33am

all of the above & then some
It is mt contention that the root of this WHOLE mess is the never ending and vicious cycle of greed fueled by lack of personal knowledge and understanding. Especially and almost wholely in the area of personal finance and need. There is a severe lack of economic education in this country. (I won't even go into my other thoughts about education in general.)
That lack of education, coupled with peoples' inherent quest for more, bigger, best (aka personal greed) fueled by those selling their goods, whatever they may be, being fueled by their own personal greed starts the cycle. It is, by its very nature, self replicating and self sustaining. Add in the financiers and their personal greeds and you have just caused the whole "system" to accelerate toward eventual meltdown, which doesn't end - only pauses until once it has reached the point of total collapse and no one has anything any longer, someone gets the idea that he wants what little someone else has and devises a plan to acquire it by some means of trade, thus rekindling the process.
W.C. Fields once said, "There's a sucker born every minute."
So, unless you want to be part of the meltdown, become self aware. Live within your means and quit listening to the "snake oil" salesmen who relentlessly tempt you to excesses you don't need. All too many people enter into financial obligations of major consequence with WAY TOO LITTLE information and NO research into how it will effect them in the long run. Arm yourself with knowledge before making any transaction, ESPECIALLY large ones and step out of the cycle. Remember also, that there will be people making copious amounts of monet through this readjustment period. With adequate information and common sense, you could as well.
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Twinrova, 3 Dec 2008 @ 5:22am

Curse you, Mike, for making me read!!!
"It wasn't (as some people want to claim) 'greed' or a 'lack of regulation' that caused the problem, but bad information (though, some might blame that on greed and a lack of regulation)."

Transparency would not have prevented this issue. Everyone knows there are risks involved with anything having long term investments. Homeowners know the risk of losing their home. Banks know the risk of homeowners foreclosing. Stock owners know the risk of the market.

Where's the lack of transparency everyone's talking about?
I've yet to see any proof disclosure wasn't present on any transaction causing the meltdown.

The notion sellers didn't disclose to buyers doesn't excuse the buyer from being stupid as to not know what they're buying.

In the mortgage world, loan sellers didn't hide anything. Regardless of the types of loans, buyers knew the loans were mortgages which carries an inherent risk. From there, the chain continues.

The chain breaks, when and only when, buyers discover what they bought was not what they were told.

This is fraud by the seller.

Fraud is done by those who are greedy.

All this fraud was done legally, so regulation wasn't warranted despite all the warning signs to the contrary.

Now, everyone suffers. Bailouts commence. Those too stupid to understand what they were buying get a second chance to fuck it up again.

Regulation is set to come to prevent meltdowns in the future, but with so many loopholes, it's impossible until the next meltdown comes.

The only thing transparent in this mess is watching families all over the world having difficulty trying to keep everything they've worked hard for while those who put them in this situation get bailed out.
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Anonymous Coward, 3 Dec 2008 @ 7:09am

Re: all of the above & then some
W. C. Fields was quoting P. T. Barnum, and so are you.
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Bil Corry, 3 Dec 2008 @ 7:38am

Trust
The issue of trust is implicated in the below article about why poor countries are poor:

We still don't have a good word to describe what is missing in Cameroon and in poor countries across the world. But we are starting to understand what it is. Some people call it "social capital," or maybe "trust."

from: http://www.reason.com/news/show/33258.html
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Mike (profile), 3 Dec 2008 @ 10:24am

Re: Re: all of the above & then some
W. C. Fields was quoting P. T. Barnum, and so are you.

Actually, they were quoting David Hannum, not Barnum.

http://www.historybuff.com/library/refbarnum.html
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Mike (profile), 3 Dec 2008 @ 10:30am

Re: Curse you, Mike, for making me read!!!
Transparency would not have prevented this issue. Everyone knows there are risks involved with anything having long term investments. Homeowners know the risk of losing their home. Banks know the risk of homeowners foreclosing. Stock owners know the risk of the market.

Whoa. On this, you are very, very, very, very wrong.

The problem, if you read the details, was that people DID NOT know the LEVEL of risk. They understood there was risk, but the amount of risk was misrepresented repeatedly. CDOs made up of the lowest tranches of other CDOs yet rated as AAA? That's a lack of transparency.

Muni's told that their buying bonds, but are really buying insurance on those bonds? That's a lack of transparency

Banks hedging against each other with CDSs over and over again, such that the actual risk is totally hidden? That's a lack of transparency.

Twinrova, you have a way of jumping to conclusions. Claiming that all risk is equal is simply wrong.

Even today, the people who are holding toxic assets have no clue what's in them. That's a major lack of transparency.

All this fraud was done legally

Uh. You can't do fraud legally. Check the definition of fraud.
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nasch, 3 Dec 2008 @ 10:44am

Re: false value is a real issue
The only problem with letting them adjust (well a problem, maybe not the only one) is that millions of people would then be underwater on their mortgage. Way, way underwater if it was a 70% reduction as you suggest. So, many people would be unable to sell their homes because they wouldn't get enough to repay the mortgage. So people wouldn't move. Little new home construction, perhaps even to the point where many contractors go out of business. Few buyers on the market. Prices crash even more. Even more people are underwater and can't move out. Some people will lose jobs (unrelated), be unable to find work, and unable to move somewhere else to find work, so default on their mortgages. Now banks own homes that are worth far less than their mortgages.

How do you suggest that situation would be dealt with? And would it really be better than the alternative? Maybe something in the middle - try to keep home prices fairly stable, not rising and not crashing.
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nasch, 3 Dec 2008 @ 10:50am

Re: Re: re: false value is a real issue
Automobile prices are also much higher priced than they should be

What a strange statement. Why "should" cars be cheaper?
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