To Disclose or Not Disclose?

Is disclosure a problem? Or is transparency the problem as some people would like us to believe it is? For example many say that had they had transparency then we would not be in this sub-prime and credit mess. In the book Demon of Our Own Design a case was made that transparency is a bad idea.

Of course you might not believe me, so instead of arguing some abstract theory I will use one example where transparency hurt, and another example where lack of transparency helped.

Case 1: LTCM

LTCM held huge positions and Scholes (one of the founders of LTCM) has long argued that the actors were not acting properly. His main argument was that people knew the positions of LTCM and were acting against them. The counter parties were bleeding LTCM more than they should have.

While I have argued against Scholes, he is quite correct in his assertion that the counter parties were behaving incorrectly. They were behaving incorrectly because they had market knowledge about the counter parties.

Think of it as follows. You are at a poker game and you have made a huge bet. Then while betting your opponents figure out your hand. They can bleed you dry because they know you can’t bluff or get out of this in any easy way.

Case 2: French Rogue Trader

An example of lack of transparency happened recently. A rogue trader in France held positions of around 70 billion euros (more than twice the valuation of the bank itself). The bank liquidated the positions in the space of three days taking the markets down for a dive. Nobody knew why the market was going down, but they sold as well and overall the European markets dropped by 7%.

One could argue because of this drop and lack of transparency the Fed dropped interest rates. The Fed did something that they should not have. But before we become too hasty to judge, let’s think of an alternative future.

Imagine the bank came out with the position of 70 billion Euros. How would the market react? The market would dry up faster than a sponge on a midday in Death Valley. All of the actors in the market would stop buying and wait for the selling to begin. They would wait and let the bank fall because they know the bank has huge positions that need to be liquidated.

You can argue that with transparency the losses tend to increase. I even wonder if the problem of our current credit market is due to the fact that the banks know about each other’s positions and are abusing that knowledge and not lending? If you are bank and you know the other bank has a huge position would you help out your competitor? Not likely.

What you should actually argue is not disclosure or transparency, but knowledge. Disclosure and transparency are cope outs for those that don’t want to think.

When you read my blog do you trust me? Do you trust me to be honest and ethical? If I was to disclose my holdings would you trust me then? The real question is why are you basing your trust on whether or not I disclose my holdings?

Warren Buffett once said (paraphrasing) that he likes not being in New York. It allows him to think critically without the hubbub of the city. You should do the exact same and you should not trust me or anybody else. What you should do is take my knowledge and think about it. Ask yourself, “is the knowledge from Christian actually in my interest?”

And if you say, “yes it is” then I have succeeded in gaining your trust. And let me tell you once I have gained your trust I do not intend to break it. Trust is hard to get and easy to break. People forget that and disclosure or transparency is not going to help that.

NOTE: You could say that how can you trust me if I don’t disclose? I say just read my blogs and keep thinking critically about my information. And if you do that, I have accomplished something that I was hoping I would, namely thinking critically.