Comment on Post: Harvard Law School Forum on Coprporate Governance and Financial Regulation: Credit Quality as a Bonus Underpin

The breakdown in underwriting standards was definitely a prime contributing factor, which allowed so much credit risk. This became compounded by various leverage factors (actual and derivative), rating’s systems and other elements. Below is an excerpt from a commentary of mine done in August 2008 on BIS Working Papers. It speaks to credit quality and transparency.

Super Anti-efficiency

“Markets can remain irrational longer than you can remain solvent.” J. M. Keynes.

“The current phenomenon occurring in the capital markets is aptly termed a “dislocation”, as the primary ultimate intermediary—as the process proceeds and as a matter of fact—will be the Central Banks, as proxies for the Sovereign Governments and institutions which they represent.

Efficient Market Hypothesis whether one subscribes or not, concludes that financial markets are “informationally efficient”. The current situation finds: these markets have gotten into their current state due to what might be termed a “super anti-efficiency”—in that data believed known or actionable was either not known or if known not acted upon. To be clear, the statement that the general markets in the main, were unaware and thus became stultified seems reasonable. But please note that in these premises, are included by reference the rules of fiduciary prudence as “should have known” or more importantly, “should have acted upon”.

What is manifest tends toward an abject systemic or asymmetric informational anomaly—coupled with lack of positive and clear-cut action. Was the notional value of “innovative” Credit Risk Transfer instruments and derivatives unknown? Were the off balance sheet operations of investment and commercial banks completely latent? Did Credit Rating Agencies have any semblance of true experiential and subjective understanding of the products being rated? Was the rapid vaporization of Enron not enough of a microcosmic event to warrant extrapolation?

From a subjective and visceral view, everyday actors for example, in Originate & Distribute model businesses and at all levels with the exception of certain investors, knew what was occurring at a daily functional level—however, sans any real understanding of the global-macro consequences. To say the least, the full picture was not widely known or if it was, not disseminated to the participants capable of realization and response.

Central Banks and Sovereign Treasuries, to be able to know and analyze macro consequences, must have access to accurate information and then the analyses are only as good as the data collected along with the concomitant ability to analyze, understand and predict distributive results and outcomes.In the final analysis, most did not perceive the true circumstance—save on an idiosyncratic micro level—and of those who did, either the full consequence was not appreciated or as inheritors, were confronted with an overwhelmingly daunting task. Thus, a condition of Super Anti Efficiency was born.”