I don’t know why people are so surprised by and reluctant to accept the narrative we had an opacity driven financial crisis.  In fact, many are dismayed by and argue against this simple narrative.  Even though the narrative accommodates all the elements of the Great Financial Crisis in all of its complexity.

As I was reading an article by James Galbraith, it occurred to me these individuals must view the financial markets as something that exists without any governmental role.  Or if there is a governmental role, the role isn’t ensuring disclosure so investors can know what they own.

As regular readers know, in the 1930s FDR and his administration redesigned our financial markets.  Specifically, they based the financial markets on transparency combined with caveat emptor (buyer beware).

The elegant notion they introduced was not only should investors have access to the information they needed to assess each investment’s risk/reward tradeoff, but each investor should know they were responsible for any losses incurred on any investment they made.  By making investors responsible for any losses, it gave each investor the incentive to assess the disclosed information either by themselves or by having a trusted 3rd party assess the information for them.

Of course, investors don’t have to assess the disclosed information.  Instead, investors can blindly bet on a security.  However, the failure of an investor to assess a security’s risk/reward doesn’t end the investor’s responsibility for absorbing all losses that result from the investor’s exposure to the security.

The financial system FDR and his administration introduced doesn’t distinguish between investments like money market securities or bonds or stocks.  It doesn’t distinguish between an investment intended to be held overnight or for 30 years.  It doesn’t create a special category of securities sold to the public that are exempt from providing investors with access to the information needed to assess the securities’ risk/reward.

In this financial system, there are no safe assets.  Each investment has risk.  Some investments have more risk than others.  In this financial system, all investments require investors have access to the information needed to assess the risk/reward of the investment so they can know what they own because all investments come with the requirement investors take the losses on what they own.  By design, all investments are always information sensitive.

The financial system FDR and his administration introduced recognizes the amount of disclosure needed varies greatly between investments, that some investments are easier to assess than others and that some investors are better at assessing the disclosed information. For example, almost everyone can assess insured deposits at a bank. Insured deposits require minimal disclosure. The FDIC insurance logo, what is paid on the deposits and any fees suffices. In contrast, far fewer investors can assess bank stocks and unsecured bank debt.  This assessment requires a significant amount of disclosure. An investor has to know the bank’s current on and off-balance sheet exposures and how they are performing in order to assess the bank’s risk/reward.

This is the system FDR and his administration put in place in response to the Great Depression.  But what system was in place before that?  It was a system with limited government involvement based entirely on caveat emptor.  In this system, it was assumed buyers would force issuers to disclose all the information they needed to assess risk and return.  FDR and his administration learned from the Roaring 20’s and the Pecora Commission investigation into the subsequent financial market collapse this wasn’t true.  Hence, they introduced transparency and made it the responsibility of the government to ensure it was provided.