Tuesday, February 24, 2009

Transparency versus clarity

Free Exchange challenges the idea that more transparency is needed from financial institutions. It is argued that the information is out there, it's just really hard to understand.
The trick is to disclose information in a manner that enhances understanding rather than clouds it. But with complex securities this is easier said than done. Meanwhile, an insistence on simple securities necessarily discourages innovation and more efficient risk allocation, resulting in less capital available to firms, and ultimately lower rates of economic growth.

The point is also brought up that consumers don't make good decisions even if they have the information and understand it.

In my opinion, clarity is part of transparency--if you have 500 pages of text to explain what a product is, the message is effectively hidden. Still, an idea popped up for me. How many people understand physiology or the science behind nutrition? I'd be willing to be the number is significantly less than the portion of people that can read a nutrition guide on the side of a food product at the grocery store.

Sure, it doesn't mean people always make healthy choices, and those labels vary in usefulness to each consumer, but they're supposedly a fairly decent guideline for the average consumer. Not everyone needs the same amount of calories per day or vitamin A per day, but it gives consumers a rough idea of the nutritional value of the products they're buying, for those who care. The point is that knowledge of biology, chemistry, or nutrition isn't a necessary condition to understand those nutrition guides.

I wonder if it's possible to make such a label for the financial industry. I would initially imagine that such a label would be either too complicated to understand or too simplified to be useful, but maybe there's a happy middle ground someplace.

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