home > by publication type > op-eds > Transparency’s Dark Side
Email
| Author: | Sebastian Mallaby, Director of the Maurice R. Greenberg Center for Geoeconomic Studies and Paul A. Volcker Senior Fellow for International Economics |
|---|
February 23, 2009
McKinsey & Company
As Wall Street has turned upside down, calls for more transparency, not surprisingly, have become increasingly intense. Markets thrive on information, the argument goes, and more information is better, right?
Well, up to a point. Investors in Bernard L. Madoff's self-described "Ponzi scheme" must surely wish that they had known what he was up to. But when it comes to hedge funds and proprietary trading desks, transparency is not always a good thing. In fact, it can be dangerous.
The reason lies in the interplay between systemic risk and leverage. The meltdown of 2008 has illustrated the cascading consequences of leverage: when a market moves against a highly indebted institution, it can go under quickly, a lesson that Bear Stearns, Lehman Brothers, and American International Group (AIG) learned the hard way. Moreover, the bankruptcy of a leveraged institution-or even just a heavy trading loss-can destabilize the entire financial system.
To see why this is so, consider an example. An institution that has borrowed ten times its capital and suffers a trading loss that wipes out $1 billion in capital will need to liquidate $10 billion worth of assets to restore its original leverage ratio. Sales on that scale will drive markets down; and if other leveraged players hold the same assets, their capital will take a hit, and they too will be forced to dump holdings into a weak market. This process of contagious "deleveraging" can build in force, causing markets to swing wildly, threatening a broad swath of investors.
To order Task Force reports, Council Special Reports, and Critical Policy Choices, please call, fax, or order online from our distributor, the Brookings Institution Press: phone +1.800.537.5487, fax +1.410.516.6998.
For information on other reports that are not for sale, or for general publications information, please call +1.212.434.9516 or email publications@cfr.org.
Start-Up Nation addresses the trillion-dollar question: How is it that Israel—a country of 7.1 million, only sixty years old, surrounded by enemies— produces more start-up companies than large, peaceful, and stable nations like Japan, China, India, Korea, Canada, and the UK? With the insights of geopolitical experts and investors, the authors examine this nation’s adversity-driven culture to answer this question and offer prescriptions for a global economy on the rebound.
In Forces of Fortune, Vali Nasr presents a paradigm-changing revelation that will transform the understanding of the Muslim world at large. He reveals that there is a vital but unseen rising force in the Islamic world—a new business-minded middle class—that is building a vibrant new Muslim world economy and that holds the key to winning the cold war against Iran and extremists.
In Cuba: What Everyone Needs to Know, Julia E. Sweig presents a remarkably accessible portrait of Cuba's unique place on the world stage over the past fifty years, including its internal politics, its often fraught relationship with the United States, and its shifting relationship with the global community.
Complete list of CFR Books
Copyright 2009 by the Council on Foreign Relations. All Rights Reserved.