The preface to Transparency Games has aged well and is more relevant today than when I wrote it:

There are events, such as the Space Shuttle Challenger exploding or terrorists flying jets into the World Trade Center, where you remember exactly what you were doing and where you were. For me, one of those events occurred on September 23, 2008, when the United States, the world’s only superpower, surrendered to Wall Street without a single shot being fired.

Shortly thereafter, England and the European Union also surrendered.

Why did governments around the world surrender to Wall Street and England’s version, The City of London?  How could governments around the world allow the bankers to continue rigging the global financial markets and looting Main Street without any resistance?

What happened on September 23, 2008?

On that day, U.S. Treasury Secretary Hank Paulson, accompanied by then Chairman of the Federal Reserve Ben Bernanke, requested from the U.S. Congress an initial payment to Wall Street of $700 billion dollars to buy toxic assets from the largest commercial and investment banks.

In making this request, Secretary Paulson demonstrated the salesmanship and political shrewdness that saw him reach the top of one of the largest investment banks, Goldman Sachs, before becoming Treasury Secretary.

He laid out the case that the U.S. economy and particularly Main Street was facing serious problems if the banks weren’t bailed out.

It was not what Mr. Paulson said that gave his argument credibility, but rather Fed Chair Bernanke and his reputation.

Before joining the Federal Reserve Board, Mr. Bernanke had been a Princeton economics professor who prided himself on his studies of the Great Depression. In fact, he called himself a “Great Depression buff”.[1]In 2000, he published a book, Essays on the Great Depression, which included nine articles he coauthored over a period of two decades. He felt these articles presented a “largely coherent view of the causes and propagation of the Depression.”[2]

For Secretary Paulson’s argument to carry any weight, he needed Fed Chair Bernanke’s agreement with his analysis that without using taxpayer funds to bail out the banks, Main Street was facing a second Great Depression. After all, Fed Chair Bernanke had access to the same information as Secretary Paulson, and it was assumed if there was anyone who should be able to assess if this was necessary and the U.S. was potentially heading into a second Great Depression, it was Fed Chair Bernanke.

As Fed Chair Bernanke sat there with his ashen, panic-stricken face, there could be no doubt he truly believed we were headed into a second Great Depression. His visual appearance and testimony sealed the deal.

Congress did not immediately give Mr. Paulson what he wanted. Instead, they waited for over a week before surrendering.

While watching Secretary Paulson’s virtuoso performance, a single thought kept recurring to me: What am I missing? Why was the need to surrender to Wall Street for fear of a second Great Depression not credible?

It wasn’t credible because in redesigning and rebuilding the financial and banking systems during the Great Depression, the FDR Administration and Congress, seeing the damage caused by an opacity driven financial crisis, took steps to insure the banking system could survive another opacity driven crisis without being explicitly bailed out.

The FDR Administration and Congress actually went further than just redesigning and rebuilding the financial and banking systems. They demonstrated how to use the new financial and banking systems to end an opacity driven crisis and restrain Wall Street.

Why did I know there was no need to surrender to Wall Street, but nobody in the Congressional hearing on that day seemed aware of this fact or was willing to mention it?

At this point, allow me to introduce myself. Boston Magazine referred to me as the “Man who would save the economy.”[3]

During my career, I worked at the Federal Reserve in the area that developed the monetary policies that ended inflation in the early 1980s, and at a Too Big to Fail bank in its Asset/Liability Management and Capital Management areas. Subsequently, I designed, developed, and patented an information system to bring valuation transparency to structured finance securities.

In short, I have exactly the background you would expect of someone who publicly said before the financial crisis that we have an opacity problem in the global financial system. The only proven solution for an opacity problem is valuation transparency. Why is this the only proven solution?  It is only with valuation transparency that market participants can throw off the shackles of fear caused by opacity in the financial system.  Market participants need the information provided by valuation transparency so they can know what they own or are thinking of buying.  Market participants need the information so they can adjust the size of their investments so they do not have a greater exposure than they can afford to lose. Knowing what you own is the source of confidence in the financial system.  It involves independently assessing risk and reward before and after making an investment decision. By definition, an investment provides valuation transparency if market participants have access in an appropriately, timely manner to all the useful, relevant information needed so this independent assessment can be made.

As I described it in a Bloombergarticle[4] in late 2007, the problem at the heart of the global financial system was investors could not independently assess the risk of or value opaque, toxic subprime mortgage-backed securities. Why could they not independently assess the risk of or value these securities? It was the equivalent of trying to assess the risk of or value the contents of a brown paper bag. The solution was and still is to eliminate the opacity of these securities by providing valuation transparency so these deals can be assessed and valued as if the contents were in a clear plastic bag.

By September 2008, the recognized opacity problem in the global financial system had expanded. Investors now realized that assessing the risk of and valuing a bank or broker-dealer was the equivalent of trying to assess the risk of or value the contents of a black box. Just like with the mortgage-backed securities, the solution was and still is to eliminate opacity so the banks and broker-dealers can be assessed and valued as if the contents were in a clear glass box.

By September 2008, the broader solution for moderating and ending our current financial crisis was, and still is, to eliminate opacity in all the opaque areas of the financial system, so these areas can be assessed and valued as if the contents were in a clear container.

In late 2008, I observed until valuation transparency was brought to all the opaque corners of the global financial system, the global economy, absent ongoing fiscal and monetary stimulus, would remain in a downward spiral. Years later, nothing of substance has been done to bring valuation transparency to any of the opaque corners of the financial system. As a result, not surprisingly, we are still relying on ongoing fiscal and monetary stimulus to prevent the global economy sliding into a deep recession.

I am writing this book in the hope that we will recognize there was, and still is, no need to surrender to Wall Street. Every day our nation’s policymakers have to choose to continue to surrender to Wall Street and put the welfare of the bankers ahead of the welfare of its other citizens. Policymakers could make the choice today, tomorrow, or Tuesday of next week, to put Main Street ahead of Wall Street. In making this choice the crisis could be ended.

Every day our policymakers choose to continue to surrender to Wall Street, and follow policies to protect Wall Street, the same negative results occur. The real economy is further hollowed out, the growth in inequality between the rich and poor increases, our social contract is further eroded, and our nation is fundamentally weakened.

Every day our policymakers have the option to remove Wall Street’s shackles from the real economy. By doing this they can restrain Wall Street so that it engages primarily in activities that support the real economy.

Every day our policymakers could choose to bring valuation transparency to all the opaque corners of the financial system. By choosing valuation transparency, our policymakers would be choosing an eloquent, proven solution for ending the global financial crisis.  By choosing valuation transparency, our policymakers would also address many of the problems including Too Big to Fail, banker misbehavior, and regulatory capture that confront us today.

Fortunately, we don’t have to wait any longer for our policymakers to choose Main Street over Wall Street. I will present a solution in this book whereby Main Street can bring valuation transparency to all the opaque corners of the financial system.

In writing this book, I hope to answer a number of still unanswered questions about the financial crisis. In the process, I hope to explain what valuation transparency is capable of doing, and what it cannot do.

• Why did the financial crisis happen? Does an analysis of the root causes of the global financial crisis show there was one primary cause that expressed itself through a host of related symptoms or were there several underlying causes?
• Are the financial reforms and regulations introduced since the beginning of the financial crisis likely to be effective at preventing another financial crisis?
• What will it take to restore trust and confidence in the financial system?
• What will it take to end the current global financial crisis?
• Why have fiscal stimulus and extraordinary monetary policy measures not restored a self-sustaining recovery or confidence in the financial system?
• What policy responses were, and still are, available to the politicians and financial regulators to respond to our financial crisis? There are two basic policy responses: the Japanese Model, and the Swedish Model. The Japanese Model favors Wall Street over Main Street. The Swedish Model favors Main Street over Wall Street.
• Why was the Japanese Model chosen as the policy response to the financial crisis? The Japanese Model is known to have two fundamental flaws. First, nowhere it has been tried has it ever succeeded in ending a financial crisis, and then started a self-sustaining economic recovery. Second, it maximizes both the short- and long-term negative impacts of a financial crisis on the real economy and its citizens.
• Why has the Swedish Model still not been pursued? The Swedish Model has a long record of successfully ending financial crises while minimizing the negative impact on the real economy and taxpayers. It was first used by the FDR Administration, and succeeded in ending the worst of the Great Depression.
• What will it take to return to a global economy where we are no longer confronted with what Professor Paul Krugman calls a choice between unsustainable bubbles or endless depression?

To explain why restoring transparency to all the opaque corners of the global financial system will achieve more than all the complex regulations and regulatory oversight adopted since the beginning of the financial crisis, Transparency Gamesis broken down into seven sections.

The First Section

The First Section provides an overview of how our financial system and the tools to address a financial crisis have evolved since 1900. There were two financial crises, the Panic of 1907 and the Great Depression, which resulted in the creation of tools for responding to a financial crisis.  These tools included the creation of both a lender of last resort and a safety valve in the financial system to protect the real economy from excess debt in the financial system. Together, these tools dramatically changed how policymakers could respond to a financial crisis compared to the 1800s. Specifically, these tools allowed policymakers to protect Main Street and the real economy should a financial crisis occur.  Subsequently, there were several smaller crises, like the Less Developed Country debt crisis and the collapse of Continental Illinois, which allowed Wall Street and the City to capture these tools. By the time our financial crisis hit, it would be Wall Street and the City that were protected by these tools and not, as originally intended, Main Street and the real economy.

The Second Section

The Second Section looks at how our financial and banking systems are designed to work under the FDR Framework.  The FDR Framework was put in place in response to the stock market crash at the beginning of the Great Depression. It built upon the Federal Reserve’s lender of last resort role and added a safety valve in the financial system to the policymakers’ toolkit for handling a financial crisis. More importantly, the FDR Framework also addressed the issue of preventing a financial crisis in the first place. It did this by adding both a regulatory infrastructure and the philosophy of disclosure to the existing principle of caveat emptor (buyer beware) based financial and banking systems.

Under the original FDR Framework, the government was responsible for implementing the philosophy of disclosure and ensuring market participants have access to valuation transparency for every publicly traded security.  Valuation transparency has two vital roles in the financial system. First, it is the necessary and sufficient condition for the invisible hand of the market to operate properly. Without it, one or both parties to a transaction are blindly gambling and, as a result, there is no reason to think the result of the transaction is the efficient allocation of resources.  Second, valuation transparency is necessary for market discipline. Under the FDR Framework, caveat emptor gives market participants the incentive to use the information disclosed under valuation transparency to assess the risk of each of their exposures and practice self-discipline to limit each exposure to what they can afford to lose.  The ongoing adjustment by investors of the amount of their exposure based on changes in the risk of each exposure results in market discipline.  Market discipline is the primary means for restraining bank risk taking and preventing a financial crisis.

Under the FDR Framework, it is recognized that regulatory discipline is a complement to, but never an adequate substitute for, market discipline.  There were several reasons why regulatory discipline complements market discipline including regulators are always susceptible to political pushback that weakens the enforcement of regulations.

The original FDR Framework relied on regulators to ensure valuation transparency.  As shown by the financial crises since the Great Depression, the framework’s dependence on regulators to ensure valuation transparency was a fatal flaw. To update the FDR Framework for the 21^stcentury and beyond, I introduce the investor led Transparency Label Initiative™ as the solution for permanently fixing this flaw.

The Third Section

The Third Section looks at the seeds of our current financial crisis. By looking at previous financial crises, we can see how the fatal flaw of a reliance on financial regulators to ensure valuation transparency undermined the original FDR Framework, particularly as it was applied to the Too Big to Fail banks.

One crisis in particular, the collapse of banking giant Continental Illinois, represented the culmination of banks becoming opaque. It also highlighted how regulators react to each financial crisis by substituting additional complex regulations and regulatory oversight for valuation transparency and market discipline. The Continental Illinois crisis is special because it represented a preview of our current crisis right down to the adoption of the Too Big to Fail policy.

The Fourth Section

The Fourth Section looks at how Wall Street and the City bankers were able to reintroduce opacity into the global financial system for both themselves and the products they sell. They did this by taking advantage of the original FDR Framework’s reliance on regulators to ensure investors have access to valuation transparency. The section also clears up all the misperceptions that surround valuation transparency.  Wall Street’s Opacity Protection Team created these misperceptions, like investors are stupid and lazy, to justify opacity.

The Fifth Section

The Fifth Section reviews the findings of international investigations conducted in Ireland, the UK, and the U.S., into the causes of the financial crisis that began on August 9, 2007. These investigations confirmed the reliance on regulators to ensure valuation transparency both for banks and the financial products they sold was the fatal flaw in the original FDR Framework.

These investigations also showed why regulatory discipline in the form of complex regulations and regulatory oversight was always, and everywhere, an inadequate substitute for valuation transparency and market discipline. When regulatory discipline is the first line of defense, it leaves us prone to a financial crisis that the regulators, who failed to prevent the financial crisis, will make the taxpayer pay for.

The Sixth Section

The Sixth Section looks at how opacity made possible the policy choice between the Japanese and Swedish Models for responding to our current financial crisis. Under the Japanese Model, policies are adopted that favor Wall Street over Main Street.  The goal of the Japanese Model is the preservation of the existing banks. It assumes saving these banks also saves the real economy. Under the Swedish Model, policies are adopted that favor Main Street over Wall Street.  The goal of the Swedish Model is the protection of the real economy. It assumes that saving the real economy also saves as much of the banking system as is necessary to support the real economy. This section shows the global financial system is designed to support pursuing the Swedish Model. It also shows why pursuing the Swedish Model is needed if we are to end our current financial crisis.

The Seventh Section

The Seventh Section looks at how the investor led Transparency Label Initiative™ would fix the global financial system. In addition, it would prevent opacity driven financial crises for the 21^stcentury and beyond.

This section contains three case studies and shows how the presence of valuation transparency would have prevented all three:

• Anglo Irish Bank: Bankers cynically bankrupting Ireland
• JPMorgan’s “London Whale” trade: Regulators missed it
• Libor interest rate: Bankers manipulating the price of money for their own benefit

Before going on, I want to make an observation. The global financial crisis that began on August 9, 2007, and the subsequent policy response ended trust in the financial markets, the banks, the regulators, the politicians, and the economists.

My goal in writing this story is to focus on what needs to be done to restore trust, particularly in the financial markets and the global banking system.

There are two primary benefits of restoring trust in the financial markets and the global banking system. First, it starts a self-sustaining recovery in the real economy. Second, it ends the need for both extraordinary monetary policy and fiscal stimulus on an ongoing basis.

[1]       Bernanke, Ben S. (2000), Essays on the Great Depression, Princeton, New Jersey: Princeton University Press, page vii.

[2]        ibid, page viii.

[3]     Kix, Paul (2008, February), The Man Who Would Save the Economy, Boston Magazine, http://www.bostonmagazine.com/2008/01/the-man-who-would-save-the-economy

[4]    Salas, Caroline (2007, December 4), Subprime Seizure Solution May Be in Hospital Bills,Bloomberg, http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a_gBF9OjtfQI