Taking a New View of Risk
Murky investments are suddenly out of fashion
Fault. There is plenty of blame to go around for these troubles, says Thomas McCraw, a retired Harvard Business School professor and author of a Pulitzer Prize-winning history of securities regulation. Big investors failed to investigate the risks associated with the promised high returns. Investment banks and brokers "always fight transparency because they think they make more money when they know more than their customers." Credit rating agencies gave top grades to risky ventures. And politicians and bureaucrats were too slow and fearful to rein in the party. "A confluence of forces has resulted in the evasion of the strategy of transparency on which the entire system rests," McCraw says. "That's what makes it so alarming."
While there are still plenty of cracks through which hedge funds, derivatives, and other newfangled investments continue to fall, there are signs that the markets and regulators may try to clear up at least some of the mysteries. The House has scheduled a September 5 hearing on the credit markets. And Securities and Exchange Commission Chairman Christopher Cox has asked Congress for the power to better regulate municipal bond issuers. The SEC ought to be able "to insist on the disclosure of material information to investors at the time that the securities are being sold," he told Congress in July.
Caution. But many in Washington say they are wary of doing much more since it may be better for investors over the long term if the market works things out on its own. Reforms sparked by the 1929 stock crash and the 2001 Enron collapse protect retail investors by requiring companies issuing old-fashioned stocks and bonds to detail everything from corporate tax payments to the CEO's life insurance policy, notes SEC commissioner Paul Atkins. And although hedge funds are not regulated, their managers still cannot legally lie, cheat, or steal. Most of the unregulated securities can be sold only to those with millions of dollars—who presumably know how to fend for themselves, he says. "We have to go very cautiously and look out for the long term," says Atkins, noting that too much transparency can hurt investors who think they have a good investment idea and don't want others to ruin it for them.
In fact, the market shows signs of adjusting to the new information demands. Jason Tyler, director of research for Chicago-based Ariel Capital Management, says he has noticed that brokers and investment bankers are "offering a lot more detail, unsolicitedly, to try and assure people."
Investors are also doing more research and singling out riskier investments that should have lower prices from those that have been unfairly tarnished. Christopher Ryon, who runs some Vanguard municipal bond funds, says his research team has been taking a second look at bonds they had rejected when first offered because the deals weren't either well-explained or profitable enough.
Brokers offering more information and investors doing more research and withdrawing from risky securities are all signs of a healthy correction. But history shows markets don't always cure themselves. After the 1929 stock crash and bank failures, many Americans literally stored their savings in their mattresses, hoarding money that could have been used to invest and expand the economy. If today's investors also lose faith, they may well follow suit.
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