Financial Transparency May Cost You
by David on June 1st, 2010
“For now we see through a glass, darkly;” — 1 Corinthians 13
In recent years, financial transparency has become a fetish. Demands for more detailed disclosure, along with the regulations to back it up, are constant and invariably defended on the grounds of providing more transparency.
Here is a statement issued last week by the Chairman of the Financial Accounting Standards Board, Robert Herz: “The proposal would impact the reporting by financial institutions and all other entities that have financial instruments as the goal of greater transparency in financial statements is pursued.” The Board, known as Faz-Bee, determines the rules of accounting. The proposal to which Mr Herz refers would require banks to record loans at “fair value” along with the current method of “historical cost.”
Before we get too lost in accounting jargon, let’s take an example. Say a bank makes you a $150,000 30-year mortgage at an interest rate of 5%. Under current accounting rules, the bank carries your mortgage on its books at its current principal balance as long as you keep paying. But what if, at some point in the life of the loan, rates for new mortgages rise to 8%. If the bank were required to report its loans at “fair value,” it would have to write down the value of your loan, even though you kept paying. You may say, “So what? That doesn’t change my loan.” True enough, but the prospect of having to record such a loss in the future, could very well influence the kind of mortgage the bank would be willing to make in the first place. Perhaps it would demand a higher rate, periodic rate adjustments, or a shorter term. Almost certainly, you would end up with a more expensive and less predictable mortgage. Achieving “the goal of greater transparency” might not be such an unmixed blessing after all.
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Tags: economic predictors, financial accounting, financial transparency
David,
One of the basic retail financial institution functions is to arbitrage the rate mis-match between short term savings and long term lending. That’s a dangerous business model that has been a repeated source of crisis. FIs have moved to other models: variable rate products, fee based income, and lending for re-sale, each with their own set of risks.
Sustainability is not a good thing for business because they are tree huggers. Transparancy is not good for business just for the sake of transparency.
The nexus of Sustainability (3BL, CSR, etc) is risk. A company is better off applying the principles of Sustainability according to risk: risk to the environment, to the community, to the employees, to the shareholders, to all the stakeholders.
What this article is implying is that in order for me to get a better loan, I am better off not honestly dealing with the risk of the loan. If the choice is one of choosing which is better for me money-wise, or which is better for me risk-wise, we are seeing (BP?) that risk needs to be the driver in everything. And transparency helps all the stakeholders understand what the risks are.
David’s response is that the entire process of home finance should be re-thought to create financial instruments that work well for both borrower and lender. The financial crisis was sparked by predatory lending and by mortgage products that were bound to implode in all but the most optimistic scenarios. Now would be a perfect time for Fannie Mae, Freddie Mac, and Ginnie Mae to work on making a better mortgage. I am surprised they are not.
David’s response is “I try never to imply, always simply to state. I am not saying that transparency is harmful; it is nearly always better than its opposite, opacity. My point is simply that transparency is not without its downsides. The essence of risk is that its future impact cannot be effectively measured in the present. If lenders fully priced in all the possible risks that a 30-year mortgage entails, there wouldn’t be such a thing as a 30-year mortgage. In fact, long-term mortgages are unknown in the developing world because the political and economic systems in many countries are simply to volatile to make long-term debt feasible.”