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New inductee for the Transparency Club…

Professor Joseph Stiglitz is testifying in front of the House Financial Services Committee today… from his testimony (page 9)… he just suggested breaking up some of the big banks… the benefits of scale are not evident (!!!…)

~~~ ” Transparency

Discussions of regulation must begin with transparency and disclosure.

America prided itself on having transparent financial markets, criticizing others (such as those in East Asia) for their failures. It has turned out that that is not the case. We need improved transparency and disclosure, in a form that is understandable to most investors.

Derivatives and similar financial products should neither be purchased nor produced by highly regulated financial entities, unless they have been approved for specific uses by a financial products safety commission (FPSC, discussed below) and unless their use conforms to the guidelines established by the FPSC.

Regulators should encourage the move to standardized products. Greater reliance on standardized products rather than tailor-made products may increase transparency and the efficiency of the economy.

It reduces the information burden on market participants, and it enhances competition (differentiating products is one of the ways that firms work to reduce the force of competition).

There is a cost (presumably tailor-made products can be designed to better fit the needs of the purchasers), but the costs are less than the benefits—especially since there is evidence that in many cases there was less tailoring than there should have been.

Transparency regulation is, in fact, more complicated than often seems the case.

Various aspects of the transparency agenda have long been opposed by those in the industry, and in some places, there are moves afoot to reduce transparency.

For instance, some years ago, there was resistance by those in the financial industry to the introduction of more transparent and better auctions as a way of selling Treasury bills—for the obvious reasons.

More recently, there was resistance to requirements for more transparent disclosure of the costs of stock options. Companies often do not report other aspects of executive compensation in a transparent way and typically do not disclose the extent to which executive compensation is correlated with performance. (Too often, when stock performance is poor, stock options are replaced with other forms of compensation, so that there is in effect little real incentive pay.)

As I have noted, stock options provide incentives for corporate executives to provide distorted information. This may have played an important role in the current financial crisis. At the very least, there should be a requirement for more transparent disclosure of stock options.

Mark-to-market accounting was supposed to provide better information to investors about a bank’s economic position.

But now, there is a concern that this information may contribute to exacerbating the downturn.

While financial markets used to boast about the importance of the “price discovery function” performed by markets, they now claim that market prices sometimes do not provide good information, and using transactional prices may provide a distorted picture of a bank’s economic position.

The problem is only partially with mark-to-market accounting; it also has to do with the regulatory system, which requires the provision of more capital when the value of assets is written down.

Not using mark-to-market not only provides opportunities for gaming (selling assets that have increased in value while retaining those that have decreased, so that they are valued at purchase price), but it also provides incentives for excessive risk taking. Realizing that there is no perfect information system, it may be desirable to have both sets of information provided. But at the very least, we should not abandon mark-to-market accounting. Doing so would undermine confidence in our markets.

Part of improving transparency is to restrict—eliminate—off balance sheet transactions.

There also needs to be clear disclosure of conflicts of interest, and if possible, they should be restricted.” ~~~~