PhD Economists at the BIS set off to find out if banks are opaque (hint: the BoE’s Andy Haldane referred to them in 2009 as “black boxes” and they don’t qualify for a label from the Transparency Label Initiative). They did this by looking at insider purchases (sales). They asked could you make money by buying (selling) bank stocks when the insiders did. What they found was insider purchases (sales) were not predictive of future bank stock price movement.
What caught my attention about this article was not only their findings, but how much this article pointed out the need for the Transparency Label Initiative. The authors started pointing out the need for the Initiative at the very beginning of their article.
Conventional wisdom maintains there are severe information asymmetries between a bank’s management and outside investors. … Overall, these arguments suggest banks are intrinsically opaque types of firms.
Banks do not need to be “intrinsically” opaque. Those who have seen the movie It’s is a Wonderful Life know the information asymmetries can easily be eliminated. Who can forget the final scene where the bank president is telling the bank’s depositors who he has lent their money to and the depositors realize the bank isn’t in jeopardy of failing.
There are definitely information asymmetries between the banks and outside investors. But this is intentional.
At the same time, there can also be information asymmetries between senior management of a bank and its operations. Call banks with this problem Too Big to Manage. An example of this would be JP Morgan’s London Whale. It is not clear internal information asymmetry didn’t prevent Jamie Dimon from understanding the specifics of the London Whale trade when he called it a “tempest in a teapot”. So there is no reason to think his stock purchases or sales during the same time period would convey any information.
Since opacity impairs the ability of outside investors to monitor banks, market participants alone cannot ensure financial stability.
The authors correctly observe opacity prevents investors from ensuring financial stability by monitoring the banks and exerting market discipline. This opacity is what makes investing in banks a blind bet.
So who do the authors think can ensure financial stability? The authors don’t say, but one can hazard a guess they are thinking of bank regulators. However, why do the authors think there aren’t information asymmetries between the banks and bank regulators? Could it be because the bank regulators have access to each bank’s current exposure details? If investors had access to these details, wouldn’t they be able to monitor the banks, exert market discipline and ensure financial stability?
The authors then making a compelling case for why the Transparency Label Initiative is needed. The authors observe:
Providing empirical support to these theoretical arguments is challenging, because opacity is hard to quantify.
Opacity isn’t hard to quantify. It is a zero/one variable. Either the disclosure leaves an investor valuing the contents of a clear plastic bag or the disclosure leaves an investor guessing at the value of the contents of a brown paper bag. Either an investment is or it isn’t opaque.
Please note, a label from the Transparency Label Initiative would allow researchers to distinguish between opaque firms and transparent firms. But rather than use this label, the PhD economist prefer derp.
The approach of the existing literature is to rely on measures that, in theory, should be correlated to the degree of asymmetric information between firms and outside investors.
In theory there should be a correlation, but in reality…
Based on their preferred measure of opacity, these papers compare banks to other firms. Even though these firms are used as a benchmark, many of the theoretical arguments supporting bank opacity also apply to them. For example, the reserves of oil firms are not publicly traded and their size, as well as the costs to extract them, are often difficult to assess for an outsider. The same arguments apply to firms with large investments in research and development (Aboody and Lev, 2001). Hence, the approach of the existing literature is a joint test of whether banks are opaque both in absolute terms and relative to other firms. Ideally, banks and other firms should be compared to a transparency benchmark. [emphasis added]
Hmmm…. so the authors are comparing the opacity of black boxes to the opacity of black marble and pretending there might be some difference in the level of opacity between two impenetrable black objects. Pure derp.
However, the authors did discover ideally there would be a transparency benchmark. Fortunately for them, the Transparency Label Initiative’s label sets this transparency benchmark.
However, in the absence of the label, the PhD Economists continue pursuing derp.
Two insights follow from this evidence. First, banks are opaque, but not more than other firms. Second, banks are opaque only with regards to good news, which is the type of information that presumably motivates purchases. By contrast, sales are not driven by negative news or, if they are, insiders do not enjoy an informational advantage.
Of course, two ideas never occurred to these PhD Economists. First, maybe the opacity of the banks and the other firms needs to be addressed. Second, the reason insider purchases (sales) didn’t convey much information despite being mined for any hint of statistical significance is many of the banks in their study were too large and complex for the insiders to understand and therefore trade on advance knowledge of the banks’ future performance.