Self-serving self-censorship in a crisis

In a crisis, the only thing that is not censored or self-censored is the market (provided it has not been regulated out of existence or into meek submission). That is the lesson that we can learn from a rare candid admission from a well known columnist at one of the most respected financial newspapers in the world. In his latest “The Long View” column (link behind paywall) in the Financial Times yesterday (September 9, 2018) John Authers writes:

It is time to admit that I once deliberately withheld important information from readers. It was 10 years ago, the financial crisis was at its worst, and I think I did the right thing.

…

There was a bank run happening, in New York’s financial district. The people panicking were the Wall Streeters who best understood what was going on.

All I needed was to get a photographer to take a few shots of the well-dressed bankers queueing for their money, and write a caption explaining it.

We did not do this. Such a story on the FT’s front page might have been enough to push the system over the edge. Our readers went unwarned, and the system went without that final prod into panic.

There are many things going on here that are worth pointing out:

1. If we go back to 2005 or 2006, the financial elite was as clueless as anybody else about the crisis that was round the corner.

2. However, during (or even just before) the crisis, the financial elite had a pretty good idea of the most vulnerable entities in the system. I remember when I discussed the matter with smart finance people back in 2007 and 2008, we could all agree on which banks (both in India and globally) were at grave risk and which were sound. In retrospect, those judgements were largely correct. At the same time, outside of finance, this understanding was often lacking.

3. This phenomenon was not peculiar to the global financial crisis of 2008, but was true in earlier crises like the Asian Crisis of 1997.

4. Self censorship is the main reason why the common knowledge of the financial elite does not percolate to the general public. Many factors play a role here:

   • We all fear retribution from the state which can easily accuse the messenger of sedition or treason.

   • There is the risk of defamation suits from the affected entities which might not have enough money to repay their debt, but are never short of money to pay their lawyers.

   • Our views are often based on inferences rather than hard facts, and we shy away from making sweeping statements in public without objective data.

   • Like John Authers, we might worry that what we write might become a self fulfilling prophecy.

5. But Authers’ story also points to a very uncomfortable fact, that our self censorship is self serving. We might hesitate to write about what we know, but we do not hesitate to act on that knowledge. Authers writes that he shuffled his money around so that he would not lose much if Citi failed. I recall that every company on whose board I served took preventive action to protect the company’s cash surpluses.

This means that, in a crisis, the general public cannot expect the elite (regulators, media, academics) to warn them or to tell them the truth. Meanwhile, the rich, powerful and well-connected are duly warned, and are able to protect themselves. Is it any wonder that the general public listens to wild rumours rather than to mainstream commentators?

There is one place where the public can learn the truth, and that is the financial markets. In the build up to the crisis, the markets are as complacent as everybody else. But during the crisis, the market is the fountain head of information. If I could make sensible judgements during 2008, it was only because I was tracking many different markets. Of course, one needs to know where to look: sometimes the most valuable information is in the spread between two arcane markets.

The governments and regulators know this very well and work overtime to ensure that the markets become uninformative. After Lehman failed, I had two blog posts on how successful government around the world had been in doing this (Towards a market only for buyers and More on market for buyers only).

Months before Lehman failed, I wrote this:

I believe that this crisis has shown the power and utility of financial markets. Policy makers have had at least a year of lead time to deal with the problems in the real economy. Without mark to market and without liquid ABX markets, the crisis would have become evident only when mortgages actually defaulted. By then it would have been too late to act.

It is difficult to persuade people about this in today’s context, but even today it is true that with all their imperfections and tendency to malfunction during crises, financial markets are the closest thing that we have to the crystal ball that reveals the future. Everything else is backward looking.

After reading Authers’ confession, I would add another clause to the last sentence: “Everything else is self-censored.”

Posted at 5:58 pm IST on Sun, 9 Sep 2018         permanent link

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