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Listen Up Investors: You’ve Been Very, Very Bad

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The President’s Working Group on Financial Markets has figured out who is to blame for our current financial turmoil, and it turns out it’s you! That’s right. Buried deep in the twenty-one page report are several paragraph chastising investors for not disciplining the markets. Spare the rod, spoil the boom!
“Although market participants had economic incentives to conduct due diligence and evaluate risk-adjusted returns, the steps they took were insufficient, resulting in a significant erosion of market discipline,” the PWG report states.
To remedy that situation, the PWG would like regulators to require investors to “obtain from sponsors and underwriters of securitized credits access to better information about the risk characteristics of such credits, including information about the underlying asset pools, on an initial and ongoing basis.”
Masked under that bureaucrat-speak is a bit of government planning. It may now be clear that investors undervalued information about structured credits. But that tells us preciously little about what the “right” level of information should be in the future. And it’s trickier than you might think to get an answer. Require too little information, and you risk another round of malinvestment from investors made over-confident by false bureaucratic assurances. Require too much information, and you wind up damaging returns on investment by increasing the cost needlessly.
It’s a shame we can’t have some kind of market process to work out this kind of thing.
Policy Statement on Financial Market Developments [Wall Street Journal; pdf file]


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