Hedge Funds Had Transparency — What about Other Investors?

This morning’s Bloomberg report makes it sound like the idea of transparency is gaining salience:

The philosophy behind both the public-private partnerships and the stress tests is that the more information investors have, the better the markets work. That’s in contrast to the stance taken by Japan in the 1990s, where executives regularly low-balled loan losses only to eventually have to come clean later.

And yet the assumption that free markets need good information to work is assaulted in the next paragraph:

While U.S. regulators don’t intend to publish the details of their stress tests, the results will effectively become known once it is determined how much capital each bank is required to raise, either from investors or the government. The more capital needed, the worse off the bank.

Such a “one-off” mechanism seems to discount the fact that much of the “stress” comes not from the quality of the assets themselves, but from uncertain information about the assets. Making data available “on-line” isn’t enough. For markets to work, materially accurate data must be available in formats that the market can use to impose market discipline.

According to Wired, two hedge funds had this data in 2007:

…a former Microsoft executive, assigned four engineers to categorize and standardize the [now “toxic” asset] 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 [assets] 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.

Too bad more people besides those hedge fund managers didn’t see the opportunity to go short sooner. Had that information been available to the public, short selling might not have suffered the injury to its reputation it’s seen over the past year.

Wired’s prescription speaks for itself: All investors should now have the information those hedge funds had. Memo to Secretary Geithner: Call Phil Moyer.