In a terrific article, Pam and Russ Martens highlight why opacity is the necessary condition for a financial crisis and how nothing has been done to address opacity.

If you want to very quickly understand why banks stopped lending to one another in 2008, credit markets froze, bank stock prices collapsed, and the Federal Reserve secretly pumped $16 trillion into banks, just take a few moments to study this chart from the Financial Crisis Inquiry Commission of the derivatives casino that Goldman Sachs and the major banks on Wall Street had become in June of 2008.

Wall Street banks knew they had created a collapsing house of cards but they didn’t know just how much exposure each bank had or which bank would fail first, so they simply stopped lending to each other, causing a run on the banks…

Please re-read the last sentence again.

Why didn’t the banks know how much exposure each bank had?  Opacity.

What happens when the valuation story of an opaque security is called into doubt?  Investors run as there is no way to verify the story or value the security.

Now take another deep breath because the tragic truth is that little has materially changed in this situation today.

This is a very important observation.  The banks are still opaque.  Many of the derivative securities are also opaque.

The problem of opacity was so significant even the Financial Crisis Inquiry Commission found it.  As its Chair Phil Angelides said,

As the financial crisis came to a head in the fall of 2008, no one knew what kind of derivative related liabilities the other guys had. Our free markets work when participants have good information. When clarity mattered most, Wall Street and Washington were flying blind…

Yet, policymakers did nothing to bring transparency to the opaque derivatives market or the opaque banks.

Why?

The Opacity Protection Team prevented it.  For example, it kept the whole idea of an opacity driven crisis out of the official narrative of the financial crisis.

Here is Ben Bernanke’s 10th Anniversary version of financial crisis narrative delivered on September 13, 2018.

The chart below shows some representative financial data, which in turn illustrate four stages of the crisis: the collapse of investor confidence in subprime mortgages, the beginning of broad-based pressures in funding markets, panic and fire sales in the markets for securitized credit (including non-mortgage credit), and the deterioration in the balance sheets of banks and other lenders….

In the figure, the variable marked “Subprime,” derived from an index of market valuations of subprime mortgages, shows investors’ developing concerns about the housing market and mortgage-related assets.  In this first stage of the crisis, these concerns grew as house prices declined and mortgage delinquencies rose beginning in early 2007.

The variable marked “Funding,” is a measure of stress in the short-term funding markets that banks use to finance their daily operations. The series rose (showing greater stress) in August 2007, after France’s largest investment bank, BNP Paribas, announced it was unable to value the assets in three of its largest investment funds, kicking off the second stage.  Funding stress reached its peak following the Lehman Brothers bankruptcy in September 2008 but came down by the end of the year as various government programs took effect.

The third stage of the crisis, shown by the series market “Nonmortgage Credit,” reflects the indiscriminate spread of the panic from mortgage to non-mortgage assets. Funding strains and a general loss of confidence in securities backed by private credit forced investment banks and other lenders to sell large quantities of risky assets, often at fire sale prices.

The final series, labeled as ‘Bank Solvency’ indicates the deteriorating balance sheets of large commercial and investment banks caused by mortgage losses, funding pressures, and fire sales. As this variable shows, in the fourth stage of the crisis, bank health worsened steadily through early 2009 (higher values imply a higher risk of default), improved following regulators’ stress tests of large banks that spring, and worsened again at about the time of the credit downgrade of the U.S. government in 2011 and continuing pressures in Europe.

Absent from his version of the financial crisis narrative is any mention of opaque banks or opaque securities.

Mr. Bernanke’s four stages of the crisis is simply a description of the earthquake as it spreads along the financial system’s opacity fault line.  What started in opaque subprime mortgage-backed bonds spread to opaque investment banks, then spread to the other opaque structured finance bonds and opaque shadow banking securities before finally spreading to the opaque banks.

Of course, if he had mentioned opacity, it would have called attention to the fact the official response to the financial crisis did not make any effort to bring transparency to the opaque corners of the global financial system.

In fact, the official response to the financial crisis was an attempt to make financial crises and taxpayer funded bailouts a more frequent occurrence by making large opaque sectors of the global financial system a permanent fixture.