Friday, August 24, 2007


"Capitalism without failure is like a religion without sin."

Allan Meltzer

France responded to recent turmoils and frictions in credit markets by calling for tougher and tighter regulation of global financial markets. Clearly, recent dynamics of credit markets and ECB's strongest intervention yet, reflect the turbulence and heating of risk over debt securities in avoiding speculation and credit default swamps which notably increase the probability of financial crisis (Mishkin, Herbertsson 2006).

The question is whether regulative pressures to disclose more of particular data and information about traded financial products could ease the credit flows and ensure more transparency. Since information is the most valuable tool in picking-up financial products to invest in particular assets with sufficient return predictions, adding trickier code laws would simply burden the ability of financial markets to catch growth momentum and enforce risk management rules to respond to the volatility of the level markets properly. Risk management is of course an important aspect of decision-making in globally competitive markets. In addition, pressures for more information disclosure would enforce control over credit and broadly financial markets.

Financial markets are faced by risks and shocks every day and failures which occur frequently could hardly be a reasons for imposing more regulation on decision-makers. One of the ways to confront risk-taking and risk-minimization measures is to ensure a broader access to particular funds, thus to provide sound sources of liquidity.

Recently, France's finance minister stressed (link):
"We have been proven right. We need more transparency and better governance in financial markets and we need it on a G-7 basis."

The evaluation of risk which investors and creditors face in the course of financial market, crucially depends on the ability to reduce the risk of biased information regarding decision-making in particular activity, say hedge fund industry or private equity investment. Transferring the liabilites of governance and transparency to a global body would fail already in the short-run because the amount of information needed to be absorbed and the lack of acceptance of risk in terms of responding to the outcome of the excessive regulation, are the prime reasons why globally enforced regulation would punish and penalize financial markets which could face significant distortions and risk aversion leading to lower returns and discounted ability to target particular markets with particular financial products respectively.

Recently published in Wall Street Journal, Allan Meltzer wrote a simple fact which politicians obviously can't understand:
"But whatever the perceived problem, more regulation is not the answer. It is far better to change some incentives for excessive risk-taking."

Because the regulation of credit and financial markets does not achieve stated objectives, information-sharing pressure reversingly forces equity investors, traders and market actors in particular financial industry to disclose the information required and this, in turn, leads to more complexity and government's control over the financial markets to go for an intervention which is perceived as a negative affection of stock market performance. For instance, could the regulation of carried risk in hedge fund industry really ensure more transparency if trading is conducted on the basis of contract deals where the treatment of information is regarded as contract stakers negotiate.

If the assessment of risk is perceived as low and underestimated, than the portfolio and price reassessment boosted by spontaneous market behavior would give bankers, traders and investors a far better incentive to re-evaluate the risk involving repackaged debt securities. A regulation such as proposed by France's policymakers rather induce external risk pressures to hit hedge fund industry, stock market and private equity firms, causing more harm than good.

The cinism of France's minister of finance is well seen:
"It's not a question of forbidding trading or barring market activity, it's making sure that the sophistication of financial products does not get so complicated that even investors dealing in those products are lost as to what they actually are."

So according to this statement, government officials know better how and where to allocate market resources to maximize the return from financial markets by purchasing traded products at agreeable conditions to traders and investors/purchasers. Market fluctuations are a daily reaction to innumerable decisions and contracts in the financial markets. The assessment of product sophistication could hardly be attached to government's responsibility. The proper degree and size of regulation is much better managed trhough contract deals at which both sides agree on terms and conditions involving particular products to take action in financial markets. In sum, transparency of particular financial products is the matter of the contractual enforcement and the reflection of dealing preferences and the overall efficiency of trading and financial markets always gets worse when government decides to intervene the market with excessive regulation whereas the cost adjustment is high; both for the cost of government and the private trading sector's ability to akin compliance burden.

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