According to the quip of John Maynard Keynes, the only things certain in this world are death and taxes. As we now know, Keynes was wrong about this, as he was wrong about other things as well. The current financial crisis has revealed a few more certainties.
These include that people will sometimes make poor investment decisions; that people who make poor decisions will blame the government, not themselves, for their losses; and that the government will then blame financial institutions for allowing people to make those poor decisions. The final certainty is that government will propose a raft of new legislation aimed at better "disclosure".
In the midst of the global market turmoil, the rush to require more disclosure satisfies the urge of politicians to do something. However, more disclosure wouldn't necessarily improve people's understanding of what they are investing in. Even if it did improve their understanding, there's no guarantee that people wouldn't make exactly the same decision.
"Protection of retail investors" was the buzz phrase of this week's policy conference of the Australian Securities and Investments Commission. Like most buzz phrases, the concept is meaningless. It's unclear from what retail investors should be protected. There's no way that they can or should be protected from incurring losses.
It has often been claimed that peddlers of exotic financial instruments don't explain the risk their investments involve. But it's difficult to imagine what more retail investors can be told beyond that they could lose their money. Individuals make financial decisions and other decisions for a host of reasons. Often those decisions are emotional and irrational. With the benefit of hindsight they are decisions that were obviously doomed to result in disappointment. The proof of this can be seen in everything from misconceived marriage choices to buying lottery tickets.
At the ASIC conference, there was discussion of evidence that showed that around half of all adult Australians don't possess the levels of literacy and numeracy necessary to comprehend standard disclosure documents. But increasing the length of disclosure statements won't improve this situation. The failure of the nation's school system to properly equip Australians with the skills for daily life is not the fault of our financial institutions.
Banks are in an impossible position. If they don't lend to people deemed unable to comprehend what they are doing they will be accused of discriminating against the low paid and the low educated. But if they do lend to such people they will be accused of being "predatory". As Sinclair Davidson of RMIT University has recently pointed out, such is the situation in the United States.
In the 1970s and '80s, through measures such as the Community Reinvestment Act, American banks were in effect forced to offer credit to minority groups. In 1993, the Boston Fed even published a document entitled Closing the gap-A guide to equal opportunity lending that stated: "Policies regarding applicants with no credit history or problem credit history should be reviewed. Lack of credit history should not be seen as a negative factor."
The banks did as they were told by the regulators, the banks made money, and everyone was satisfied. Twenty years later, the situation has changed.
In the US a few days ago, Barney Frank, chairman of the House Financial Services Committee, warned that regulators would crack down on banks offering loans to people on low incomes with bad credit histories.
Frank alleges that one of the causes of the sub-prime crisis was the desire of too many Americans to buy a house. He said that he wished that every American "had enough sense to own a home" but sadly this was not the case.
It is not for the government to decide whether people have enough sense to take out a mortgage or make an investment decision. No amount of disclosure will protect retail investors from their own cupidity.
Thankfully it appears that ASIC chairman Tony D'Aloisio has taken a new and refreshing approach to the issue of regulation. In response to the collapse of various property trusts, he's said that before he seeks any new legislation he'll first use the legislation that is already available.
Recognition that more regulation is not the answer to every financial crisis is a welcome change from the usual attitude of our regulators.
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