For months now, we've been feeling the effects of a meltdown in our financial markets, considered by most reasonable people to be the root cause of our current economic woes, both nationally, and globally. Our financial markets remain in pretty bad shape, with little (it seems) being done to improve the situation other than throw money at financial institutions (much of it with zero oversight or accountability). Lots of money is being thrown into the economy, generally, via the stimulus package, too, of course-- lots and lots of it. And it has been claimed that all this will work.
I've been skeptical of that thinking for some time-- or at least skeptical of the notion that they will work on their own. If things going wrong with the financial markets is the root cause of the situation we find ourselves in, then it seems that focusing on sorting out the financial markets would be key. "Sorting out" should not imply throwing money at (or just throwing money at) the "problem," it should imply looking at the root cause of things going wrong, which I (and many others) would argue was debt being made too widely available (specifically to those who couldn't afford it), packaged up, and sold on (and often on from there), frequently-- and this is the kicker-- with too little clarity as to the underlying value of assets packaged up and no real way for those involved in the selling-on process (or those who ultimately acquired financial instruments representing chunks of big pools of debt) to really, truly understand the value, or lack thereof, of what they were selling or, alternatively, had purchased. Basically, bad debt became far too much the norm, and the risks associated with it were spread around quite widely, in an environment where lack of clarity as to real value was quite normal. So, when debtors started defaulting en masse, the pain ended up being felt widely-- very widely-- and people were shocked. They'd thought investments they'd made were safe, but they weren't. And in most cases, this was unlikely the result of fraud. It was very likely the subject of... confusion.
Read this article from WIRED (reprinted in Conde Nast Portfolio). Before you get through the whole thing, ponder just this excerpt:
Phillip Moyer, CEO of Edgar Online, walks into his conference room in midtown Manhattan a half hour late, clutching an inch-thick stack of copy paper. He's a broad-shouldered guy with dark brown hair pushed back from his forehead, as if a fan is constantly blowing directly onto his face. He slams the paper down theatrically: "One reason I'm a little bit delayed is that I started printing out a Bear Stearns free writing prospectus," he says. "The assets cover 462 pages. I got about 70 pages through."
Every bank that issues mortgage-backed securities—pools of home loans packaged together and sold as a single entity—is required to file a free writing prospectus, which lists every individual mortgage in each pool. An FWP contains endless columns of pure data, most of which don't even track from page to page. And each FWP is different: The banks have no uniform information that they're required to present in their filing. Even when they do report the same data, they do so using entirely different language.
You can probably see where I'm going with this, but here's a simple comment to summarize: Instead of upstepping regulation, bigtime, or just pushing for more transparency, or heck, even spending more money to try to fix the financial markets problem, maybe the objective should be to make the data that is disclosed by financial institutions in relation to mortgage-backed securities more accessible and easy to understand and analyze. As the article says, "somewhere among all this impenetrable code [FWP contents] lie the bugs that destroyed the American economy," as Moyer evidently found out: [intro]
Moyer discovered this in the spring of 2007, when two hedge fund managers independently asked for his help in making sense of some major banks' FWPs. Poring through all that paperwork by hand would take countless hours, and they wanted Moyer to extract and package the data in a way they could easily understand. Moyer, a former Microsoft executive, assigned four engineers to categorize and standardize the FWPs' contents—creating a Rosetta stone that could translate the 600 unique, inconsistent fields into 100 uniform categories. Three months later, he started delivering spreadsheets that clearly spelled out the risks in each of the pools, giving the financiers the ability to evaluate every aspect of the loans: location, proof of income, interest rate, appraisal value, and so on. They could drill down and compare the FWPs in a way that would have been nearly impossible before. And what they saw was a nationwide crisis in the making—as adjustable-rate mortgage rates ballooned, countless home-owners would default on their loans, rending the securities built on them worthless. (my emphasis)
The article goes on to argue that everyone should have access to the same data (or, rather, data-analyzing tools) as Moyer-- ordinary folks could have come to the same conclusions he did. That, the author argues, would have enabled the market to "self-regulate" as "banks, anxious to protect their reputations, would have stopped offering them [risky mortgage-backed securities]" and as "risk-fearing investors" would have "fled from companies holding or issuing the risky securities." This could be particularly facilitated, the article notes, were companies made to "file their data in a standardized format from the very start." This would, of couse, entail a small amount of additional regulation (essentially, mandates as to how a company must be transparent). But it would be far less onerous than some regulation that could potentially be advocated (e.g., "banks cannot pool debt of a certain type or with certain characteristics, at all"). And rather than having an outsized and often overburdened government act as a check on bad behavior (the article notes that "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"), ordinary citizens would be much better-placed to do so.
Why would they want to, you ask? Well, while this is not an exact correlary, some people didn't understand why I spent hours and hours back in August 2006 calling Senate offices about a "secret hold" apparently placed on the Federal Funding Accountability and Transparency Act legislation (I'm sure Glenn Reynolds from Instapundit and Paul Kiel at Talking Points Memo garnered similar responses from some friends, too). Still, I-- and they-- did, and it was in the course of this that we ultimately learned that both then-Sen. Ted Stevens and Sen. Robert Byrd had, um, issues with the bill. More similarly, as the article notes, Nate Silver did a lot of analysis of polling data in the run-up to last year's election, and was able to predict outcomes pretty well-- something that he appears to have done just for fun, or personal interest.
While I personally find politics sexier than I do financial data (hey, that's one reason I'm no longer a corporate lawyer), I don't believe for a second that there aren't whip-smart people out there who wouldn't scrutinize standardized, disclosed financial data if it were readily available. Maybe it would be better to let them have at it and try a sunlight/street lamp approach here (first) than to re-up heavy regulation and potentially hamstring more sensible banks and financial services providers when we get back to non-crisis mode. Personally, I'm inclined to think so, though I'll be interested to see what (if anything) others have to say about this.
Update: I should clarify that it is generally accepted that over-leveraging, in addition to (and more so, even, than) a lack of clarity as to real asset values, was a significant problem that contributed in great measure to the meltdown. Personally, I dislike the idea of legislating maximum leverage ratios-- a lot (it feels hyper-intrusive) and I suspect that transparency and accessibility of data could be quite valuable, if not a 100% solution (or even better than a 50% solution) to prevent this kind of thing going forward.