The transparency fight

Bloomberg

When it comes to transparency, the world’s bankers won’t surrender without a fight.

Even with capitalism suffering its biggest crisis since the Great Depression - a meltdown born and nurtured in opaque markets from subprime mortgages to credit-default swaps Ğ the bankers gathering with politicians in the Swiss resort of Davos today may be unwilling to allow too much sunshine into the dark corners of their business.

"The financial system will kick back against transparency," says Joseph Stiglitz, the Columbia University economist and Nobel Prize winner who will be in Davos. "Those working in markets see information as power and money, so they depend on a lack of transparency for success," says Stiglitz, who won his Nobel for research on information asymmetry - what happens when one party in a transaction has access to knowledge that others don’t.

The resistance may set up the ultimate test of strength between markets and governments. As the global slump deepens, and U.S. President Barack Obama promises to exert a "watchful eye" over the financial system, the risk is new rules won’t be strong enough to stop banks circumventing them.

Playing the game
"Without teeth, the banks will roll right over this stuff in a couple of years," said Roy Smith, a former partner at Goldman Sachs. "Wall Street is filled with big guys. They know ... how to play the game."

Bankers, once hailed as Masters of the Universe, return to the seminars and parties of the World Economic Forum’s annual meeting chastened by losses and writedowns that top $1 trillion. Some won’t be back at all. Former Merrill Lynch chief executive John Thain, originally slated to be in Davos, lost his job Jan. 22. A year after Lehman Brothers Holdings head Richard Fuld sat on a panel discussing sovereign wealth funds, his bank no longer exists.

Policy makers are now tightening their grip on the financial system. Timothy Geithner, Obama’s pick for Treasury Secretary, last week called for "comprehensive" regulatory changes. The British government has bought stakes across the banking industry and European Central Bank President Jean-Claude Trichet is pumping unlimited funds into the money markets.

"The pendulum of power has swung from financial institutions to politicians," says Morgan Stanley Asia Chairman Stephen Roach, who was among the first to raise the specter of global recession last year in Davos.

Obama will be represented by White House adviser Valerie Jarrett at the conference. She will join Trichet, Brown and more than 2,500 other executives, officials and government leaders. One of their main pushes will be to illuminate the murkier market practices that evolved during the boom. Banks pushed more and more of their investments off their balance sheets and beyond the reach of capital requirements. At the same time, subprime mortgage loans were repackaged into derivatives and became toxic as rising interest rates sparked a wave of defaults.

Obama wants to strengthen capital requirements on mortgage securities and derivatives and force banks to better disclose the assets they hold. British officials are pushing for similar measures and Trichet’s ECB is angling for a bigger role in monitoring banks.

One of the problems for governments is that new securities laws are often so complicated that legislators need help from industry to craft them.

"The complexity of the legislation works in the industry’s favor," says Paul Mahoney, a regulation scholar at the University of Virginia. The thrust of new regulations might be against banks, "but when it gets time to get the details down on paper, they can have real influence."

Looking back in history
That problem is almost as old as finance itself. In the 1690s, the dawn of share trading in London, brokers turned a government crackdown on short selling to their advantage. They persuaded Parliament to include in the new rules a ceiling on the number of legal brokers to 100, effectively locking rivals out of the system.

Franklin Roosevelt’s Truth in Securities Act, signed into law in 1933, met a similar fate. Aiming for better disclosure in the aftermath of the 1929 crash, the law ultimately helped major banks by freezing the existing underwriting system in their favor, says Mahoney.

"Many in the financial industry are ethically challenged and that has to be realized," says Stiglitz. "What you don’t know is the source of Wall Street’s profits. The next crisis will also be about ’if only we knew’ too."