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Missing: $40 trillion. Not billion or million, but $40 trillion went lost in broad daylight, under the watchful eye of tens of millions of players. How, in the name of all that's holy, does a thing like that happen?

There's the rub: Nobody has any idea. But the fact is that the market of CDS - credit derived securities - is worth between $15 trillion and $55 trillion. That gap is telling - it suggests that nobody actually knows how much it's worth. And nobody can explain how a market of such elephantine proportions could roll along without anybody knowing such basics as what its value is.

"How did $120 bilion evaporate?" wonder analysts about American International Group, now semi-nationalized. These analysts have been spending their days, and dreaming at night about, reading through AIG's financial statements over and over and over. Yet they can't find a single mention, neither hint nor whisper, of the company's gigantic investments in CDS, or to what degree such investments in CDS might have put it at risk. So much at risk that AIG had to beg the Federal government to save it.

Whether it's $120 billion or $40 trillion, these are numbers so large that it doesn't even matter any more. The fact is that, under the watchful eye of the American capital market and of the entire planetary capital market, complete parallel worlds were formed, dark worlds that nobody above ground even knew about and that nobody at all properly understood. Even the managers who ran these underworlds didn't understand the golem they were creating.

It shouldn't have happened. Isn't the global financial market transparent and efficient? Isn't supervision over it state-of-the-art? Wasn't it supposed to be the perfect machine, cold and unfeeling, unforgiving of people or institutions that make mistakes? All the information should have been available for the market to judge and make decisions on, according to the theory of proper disclosure, which argues that with the information in hand, the market will regulate itself more efficiently than any regulator possibly could.

Has the theory of proper disclosure now been debunked? In the little leisure time they have between the nationalization of banks and rescues of insurance companies, that is the million-dollar question regulators are asking themselves, everywhere in the world, and in Israel too. The answer they reach will shape the form of regulation in the years to come, after this crisis is history.

Not everybody believes that the theory of proper disclosure is dead: What died is its execution, some argue.

The golem was able to be crafted in the basement and then ise up against its creator because of accounting rules that allowed AIG to build and maintain an empire of derivatives without reporting them; and the fact that an American regulator decided that CDS weren't securities and didn't need to be supervised.

The lesson is that, everything is fine in the theory, except what isn't. The West needs new rules for supervising ex-balance sheet investments.

Over here, Israel can pride itself on disclosure rules that would never have allowed a golem like the world of secret CDS to develop and arise. In any case, Israel's market is far too small to enable the existence of parallel worlds. Somebody would squeal to the regulator.

There are, however, others who believe that the problem goes beyond regulation. There are gaping holes in the principle of proper disclosure itself.

Proper disclosure failed at three levels. Firstly, it failed in efficacy: It didn't stop people from making stupid decisions, in vast scale to boot.

A lot of the subprime garbage traded on America's markets were packaged with flawless disclosure, which didn't stop leading institutional investors and banks from gorging on it.

In Israel, too, companies raised billions upon billions through corporate bonds issued with zero collateral (which essentially turns them into stocks disguised as bonds), under the wide-open eye of the Israel Securities Authority.

One might have thought that expert investment managers would have avoided dangerous bonds of this type like the plague. But one would have been wrong thinking that.

It's perfectly fine to play with fire if you want to, but if the fire starts to threaten the whole economy, that freedom becomes frightening. So some regulators think they should be paternalistic and ban unreasonable transactions. If that view takes hold, it will completely change the face of the market.

The second failure of proper disclosure, say some regulators, involves the most professional of market players, the institutional investors. Assuming that they were pros, regulators in Israel and elsewhere exempted them from requiring a prospectus before investing. Given the havoc wreaked by the investment behavior of top-line institutional investors, we realize that they need protection (from themselves). They cannot be allowed to continue investing without requirements of proper disclosure.

The third failure is the assumption that the market is all-wise and can always price things properly. The fallacy of this assumption became clear as levels of weird derivatives were built, starting from a humble mortgage to an even humbler home buyer. Nobody understood these hideously complex derivatives, and consequently, nobody could price them accurately either.

You'd need a doctorate in statistics or finances to understand some of these derivatives. But most of the people on Wall Street don't have PhDs in statistics or finances. Ergo, the market trading these beasts didn't understand them. That is a recipe for disaster. Perhaps the conclusion is to ban such super-clever derivatives, and that would be another U-turn from pure market theory.

Nor is that the end of the list of holes in proper disclosure. Hard questions must be asked about the quality of proper disclosure on Wall Street and the integrity of managements and auditors. A company may seek to hide (or spin) inconvenient information, and also, the company pays the auditor. That is a recipe for trouble.

Many ideas have been touted to solve that inherent conflict of interest among auditors, and to suggest how to supervise them. The U.S. does have some supervision already over auditors, but it is confined to technicalities. It asks whether auditors follow the rules, but doesn't gauge their decisions.

Perhaps external supervision over auditors is what's needed - but that would inspect the reasonability of corporate financial statements. It would ask whether a company's results are appropriate to its size and sector, for instance. Unusual losses or profits would have to be explained.

That same system, of alarm bells and questioning the reasonability of profit, should apply to supervision over institutionals investors as well. Instead of trying to spot individual investors manipulating individual share prices, the supervisor would try to spot unreasonable profitability (or loss) by institutional investors. In the case of an "unnatural" loss, the manager would have to explain why the returns disappeared. Was it bad judgment in picking investments (indicative of a cretin)? Was he helping a friend in some other investment vehicle lift his returns (suggestive of a criminal)? It's been known to happen and will happen again. But better supervision and proper disclosure could make it happen less.