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Wednesday, April 07, 2010

Imperfect Competition in "Transparency Services"

The lack of competition in markets for "transparency services" is a problem:
The Lehman bankruptcy examiner report: And then there were none, by Michael Pomerleano, Economist's Forum: What are the broader implications of the report on Lehman Brothers issued by the bankruptcy examiner?
The report details the effort to conceal Lehman’s true debt levels through the so-called “Repo 105” structure. It finds “credible evidence” to back a claim that the failure of Dick Fuld, Lehman chief executive, to disclose the transactions was “grossly negligent”.
Anton Valukas, the report’s author, also found that there was sufficient evidence to back a claim that Mr Fuld and other executives breached their fiduciary duties by “allowing and certifying the filing of financial statements that omitted or misrepresented material information”. ...
The broader implications of this case are serious and will have lasting impact. First, transparency is at the foundation of a well-functioning system, and it relies on multiple gatekeepers such as accountants, auditors, lawyers, and rating agencies. However, instead of developing a competitive, transparent system of gatekeepers, we are witnessing the shrinking of the global gatekeepers industry. ...
We are witnessing increased concentration in a form of imperfect competition in which a large number of buyers face a very small number of sellers of “transparency” services. Clearly this market structure is prone to distortions. We are down to four big national accounting firms and three rating agencies. The rating agencies and accounting firms know that they have the regulators and financial industry over a barrel... This situation is not conducive to reforms.
A second and more troublesome problem is the incoherence in international financial regulation, which has permitted a race to the bottom in a process of regulatory arbitrage designed to maintain the hegemony of London as a financial center. ... As long as this global regulatory arbitrage continues, the forces of competition may force the most “straight-laced” financial firms, auditors, lawyers, and rating agencies to compromise their sound judgment.
The credit rating agencies and accounting firms have played a critical role in the debacle of the past two years. As a result, we are witnessing efforts to heighten regulation of the rating agencies... It is my hope that the authorities on both sides of the Atlantic will investigate the culpability of lawyers and accountants and, if found guilty, pursue action to the full extent permissible by the law. ...

The proposed financial reform legislation doesn't do much to address the problems in the ratings agencies. That's been one of the disappointing aspects of the financial reform effort. As for accounting firms, more competition couldn't hurt, and yes, we should prosecute fraud, but the more general problem of establishing reporting principles that cannot be gamed, that convey information accurately, etc. is tougher. Any ideas?

    Posted by on Wednesday, April 7, 2010 at 02:43 AM in Economics, Financial System, Market Failure | Permalink  Comments (12)


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