In her excellent review of Maureen O’Hara’s new book, Gillian White shows why restoring transparency and the Transparency Label Initiative are so important.
Ms. White does this in her summary of the book looking at whether Wall Street attracts or promotes bad behavior:
One of [O’Hara’s] main arguments is that the moral boundaries that can be so apparent in everyday life can be difficult to see, let alone adhere to, when financial firms and their workers are so often involved with purposely opaque financial products and strategies. This opaqueness represents a departure from the past.
Please note the use of the word “purposely”. It explicitly says those who are employed on Wall Street have a choice. A choice between opacity or transparency.
Why would Wall Street choose opaque financial products? Because almost no one on Wall Street has gotten rich from developing low margin transparent products. A well trod path to riches on Wall Street is from selling opaque products where the inability of investors to price these products allows Wall Street to make a high margin.
Since what counts on Wall Street is riches, it is clear what path it pushes its workers towards.
Why is this opaqueness a departure from the past? Whether it is a departure from the past depends upon how far back you look in Wall Street’s history. As the 1930s Pecora Commission uncovered, Wall Street relied heavily on opacity to boost its profits throughout the 1920s. Pecora observed,
Had there been full disclosure of what was being done in furtherance of these schemes, they could not long have survived the fierce light of publicity and criticism. Legal chicanery and pitch darkness were the banker’s stoutest allies.
So there is no reason to think Wall Street has changed and isn’t always trying to profit from opaque products and strategies.
What has changed over time has been the transparency of the products Wall Street sells.
The SEC was created in response to the findings of the Pecora Commission. It was specifically charged with ensuring all the information an investor needed so they could know what they owned was disclosed. For several decades, the SEC fulfilled this mission.
All of this changed beginning in the early 1980s. By the time the financial crisis erupted in panic mode in 2008, the SEC had come to see Wall Street and not the buy-side as its client.
This change was significant as it allowed Wall Street to create large opaque areas in the global financial system (think shadow banking where subprime mortgage backed deals and their related derivatives lurk). It was these opaque areas that were at the epicenter of the financial crisis.
With the SEC effectively abandoning its mission, the Transparency Label Initiative has stepped in to fill the void. The Initiative uses a simple label to distinguish between securities based on their disclosure. Securities awarded a label provide enough disclosure so investors can know what they own. Securities without a label don’t provide enough disclosure to assess their risk/reward and buying them is nothing more than blindly gambling.
By using the label, investors have a tool for minimizing legal chicanery and pitch darkness that allows Wall Street to engage in bad behavior.