Mapping Toxicity: bringing transparency to risk assessment

It is transparency that allows market participants to assess risk and adjust the amount and pricing of their exposures so they are compensated for the risk they are taking. 

It is the principle of caveat emptor and the knowledge that the they are responsible for all losses on their exposures which gives market participants the incentive to use the disclosed information and limit their exposures to what they can afford to lose based on the risk of the exposure. 

By limiting their losses to what they can afford to lose, market participants end concerns about financial contagion.

With that as background, I would like to share with you an article that shows how close the academic community is to understanding the FDR Framework and what your humble blogger has been saying about the role of and need for transparency.

The fiscal crisis of 2007–2009 caught people—including expert economists—off guard.

Not yours truly who is on record for having predict it.

And even as the crisis unfolded, useful insight was hard to come by. 

No they weren’t.  I offered a transparency based solution before the financial crisis heated up that would have moderated the impact of the financial crisis.

“At the end of the day, most policymakers and economists had some idea as to what was going on, but not as much as one would hope,” says Arvind Krishnamurthy, a professor of finance at the Kellogg School of Management. 

Based on the policies that have been implemented since the beginning of the financial crisis, there is zero evidence to back up this observation.

Why should this be? 

Why were the over-leveraged, so-called “toxic” real estate assets that contaminated the rest of the economy invisible even in plain sight? 

Great question. 

Why were opaque securities that hid their toxicity allowed to be created in a financial system that is based on transparency?

According to Krishnamurthy, the problem is that financial reporting practices are too outdated to capture the information necessary to accurately assess modern macroeconomic health.

“In trying to document the crisis [after the fact], you start to