Sunday, 28 October 2007

The limited role of transparency

Charlie McCreevy, EU internal market commissioner, has an interesting point about transparency in regulatory dealings. According to the FT, McCreevy will say that transparency has a useful role to play in dealing with opaque financial instruments but will add:

When the stability of a financial institution is at risk, the situation is best resolved behind closed doors. Unfortunately, in recent weeks, gold-plated transparency rules stood in the way of the quiet resolution of a problem before it became a crisis.

The result was that transparency rules that were intended to underpin investor confidence, when put to the test, actually promoted investor panic. Panic that culminated in a bank run – averted only by a central bank lifeboat which in turn spread moral hazard throughout the system.

I think the language here is a little too careless: it is not obvious that these situations are always best resolved in the dark. It was helpful, for instance, to know about the FED's Section 23A loosening. But it does seem reasonable that they sometimes are, and that supervisors and central banks should be able to act covertly if they think best, subject to later judicial and democratic scrutiny, of course. Alastair Darling certainly considers it potentially useful for the Bank of England to be able to act in secret.

This all boils down to market manipulation. Is it OK for the regulator to manipulate sentiment (and almost certainly conduct an off-market transaction) for the long term greater good? Personally I think it is, but these should be rare events. If we slide closer to Italian dirigisme, that would not be helpful.

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