The market turmoil last year led to the near "Oprahfication" of financial regulation. Markets, it seems, need empathetic solutions like those provided by daytime talk-show hosts. Like drunk and disorderly families, what they need is "early intervention." Let's get to these problems before they get out of hand, and before they are displayed and ridiculed on national television.
The government, the theory goes, should get more information circulating, watch its protectorates more closely, and perhaps ban the use of high-powered investment strategies.
This is known as "increasing transparency." Transparency will work together with "increased liquidity" (generally, government-created money) to keep confidence pumped to high levels. New restrictions will keep the new money from chasing the old, "bad" investments and channel it toward new, "appropriate" investments.
Actually, transparency is a fool's paradise. The closer you are to a company, the more you will know about it. But no matter how close you are, what matters is that trade occurs when one party places a lower value on the thing they give up in exchange for the thing they get.
Securities transactions never can be made more transparent because insight and motive play as large a role in trade as calculation. The idea of universally shared knowledge that unites market participants into a collective brain violates our most basic notion of what causes free trade in the first place. Outsiders can never know what insiders know. Information is scarce, it is a product, and you negotiate for more or less of it in trade.
Liquidity also is a scarce product. More liquidity reduces the value of information about a particular security to the average investor. Transparency, such as it is, is made irrelevant when liquidity is high. Why? Because you can reverse your decision quickly and not worry about the risk of loss.
When liquidity drops out, everyone is made ignorant all at once. Thus, the investing public stampedes to the exits. Then, shrewd investors demand more information to protect themselves from further damage. Normally, that would be rational behavior. But to regulators, the desire to be the first to avoid flu is an irrational response. Markets allegedly are dysfunctional because they are subject to bouts of contagion. Federal agencies claim to have the flu vaccine, promising no drop in liquidity will be permanent.
The idea of "early intervention" is founded on false beliefs. One is that disclosure -- the relentless publication of corporate minutiae -- will equalize the trading position of all people in the market. Another is that good supervision is the best way to monitor the fluctuating values of investment portfolios. Put another way, the static rules of outsiders are better risk management than the techniques chosen by investment firm principals who protect their own capital.
That the customer is always right is a generality in product markets; and that the counterparty is always right is the capital markets correlate. Counterparties pay the ultimate price for misjudging the nature and character of their trading party. Outside agencies attempting to micromanage the trade in information between counterparties often facilitate confusion about real risks.
There are merits to voluntary disclosures and, alternately, to keeping business property confidential. The proper mix of knowledge and ignorance is a discovery made within the market itself. The formulas handed down from supernational financial regulators will impede discovery.
