AN ECONOMIST / AN IDEA – Information obligation for investment banks and hedges on all debts

Kenneth Arrow won the Nobel Prize in 1972 also, but not only, for his theory of "information asymmetries". The idea is more or less this: information is not shared entirely among economic agents, whoever has more can influence the price or the terms of a contract in their favour. The presence of information asymmetries can generate behaviors and produce non-optimal outcomes, such as those called adverse selection (the "cans" arrive on the market instead of good goods or securities) and moral hazard (it is impossible to prevent excessively risky behaviors, because the costs do not fall exclusively on the person taking the action).
Invited to be part of the commission of economists commissioned by Sarkozy to draft proposals to be submitted to the G20 (subsequently published in February 2011), Arrow outlines the contours of the current crisis and offers ideas on how to tackle one of the problems at its root.
Agents don't have access to all available information and what they don't know they try to deduce from the behavior of other agents. For example, when stock prices start to go up or down, even if you don't know why this happens, you are led to think that someone else has the relevant information and therefore you act accordingly. But the information content of prices can be distorted precisely because the behaviors that push, for example, an increase (or decrease) of a security reflect information that is not uniformly distributed in the market.
Information, explains Arrow, is a commodity: it has a value and a cost, but it doesn't have the characteristics that make it suitable to be traded on the market; it can be transferred to others, without losing possession of it; it is not easily appropriated and is transmitted in social interaction, without any monetary counterpart.
So there are strong reasons to try to make as much financial information as available to everyone as possible, at least as much as practically possible. When an institution lends very short-term (usually 24 hours) into borrowing, the information should be readily available, so that everyone can quickly assess what conditions this institution is operating under. This also implies that derivatives such as CDS (credit default swaps) must be traded in organized markets (such as for futures and shares) which have precise trading rules and publicly disclosed prices. If prices are accessible, information on the probability of default of a security or an institution spreads immediately; then both private investors and public regulators immediately had the opportunity to act accordingly.
All the difficulties at the root of the 2008-2011 crisis have been multiplied by the level of debt of banks and hedge funds. An apparently small but far-reaching measure, Arrow reiterates, is that it is known what this level is from time to time, making it mandatory to inform and regulate the markets in which risk securities are traded. "Not letting people know" and "not knowing" in the financial markets would then be much, much more difficult.