The tenth anniversary of the Committee to Save the Banks’ decision to put Wall Street ahead of Main Street has unleashed a number of editorials bemoaning the failure to reform capitalism.

What I would say to those authors is you have completely missed two very significant developments that occurred as a result of capitalism’s near-death experience during the last ten years:  the Information Matrix and the Transparency Label Initiative.

Both of these developments offer the radical reform these authors see as missing.

Much to the chagrin of the Economics profession, the Information Matrix literally rewrites most Economic and Finance theories.  It does so in a way even a six-year old can understand it.

Information Matrix

The Information Matrix explains the design of the global financial system.  The intent of the financial system’s design is to move the vast majority of investments from Wall Street’s preferred Blind Betting quadrant into the Perfect Information quadrant.

Moving investments into the Perfect Information quadrant makes sense on a number of levels.  First, the Perfect Information quadrant is where all the theories developed under standard economics about how the market optimally allocates resources work.  Second, the Perfect Information quadrant is where finance theories work.  Third, when investments are in the Perfect Information quadrant it allows investors to Trust, but Verify the story Wall Street tells them.

Keep in mind, behavioral economics’ observation people like a good story operates in both the Perfect Information and Blind Betting quadrant.  The key difference between the two quadrants is in the Perfect Information quadrant the story can be verified and in the Blind Betting quadrant the absence of the necessary information means the story cannot be verified.

Whether the story can be verified or not results in a vastly different response when Wall Street’s valuation story is called into doubt.  In the Perfect Information quadrant, the story can be verified and the doubt dismissed.  In the Blind Betting quadrant, the story cannot be verified.  Not only is the doubt not dismissed, but the logical follow-up question arises:  is the investment worth anything?  This too cannot be verified.  Investors recognize this and, as behavioral economics suggests, naturally panic.  The result is a “run” to get their money back.

The Information Matrix framework shows why the financial crises always start in the Blind Betting quadrant.  Behavioral Economics allows us to understand the classic financial panic.  Together they explain why if you want to minimize the chances of another financial crisis, you minimize the size of the Blind Betting quadrant.

But the Information Matrix does more than this.

From an economist’s perspective, it shows information asymmetry is an interesting market imperfection, but blind betting is a much more important market imperfection (after all, no reason to think blind betting yields the same optimal allocation of resources as informed decision making).

From a non-economist’s perspective, the Information Matrix lends itself to useful real world applications like the Transparency Label Initiative.

The Initiative awards labels where there is sufficient disclosure so an investor could know what they own.  I say “could” because it is still up to the investor or a third party they trust to assess the investment.

The Initiative allows us to treat Opacity as an asset class in the same way we treat equity or debt as an asset class.  Individual investors can allocate as much or as little of their investment portfolio to opaque securities as they want.  They understand investing in opaque securities is likely to result in losing 100% of their investment, but are willing to take the chance Wall Street’s story will come to pass.  At the same time, investors like central banks, endowments or public pension funds should be prohibited from investing in an opaque security.  There is no compelling reason why they should be allowed to take blind bets.