As the US government behaves more and more like a private investor, the question of how its market activities should be regulated becomes increasingly important. One open question is: what are the right disclosure requirements for these activities? We’ve seen two answers so far. First, we have the Bernanke/Paulson “trust us” approach. Second, we have the final bailout legislation approach: lots and lots of reports to various Congressional committees (with, thankfully, one provision for rapidly reporting certain transactions (Section 114(a)) and one provision requiring financial statements (Section 105(a)(3))).
Why not impose a more established and tested disclosure regime, one similar to the financial disclosure requirements imposed on public companies, on Fed and the Treasury activities in these areas?
Let me provide one example of the pitfalls of letting the federal government make up disclosure practices as it goes along. What were the terms of the Fed’s investment in AIG? Were the warrants to purchase 80% of AIG offered at a particular price? If you go to the Fed web site you can only find the vague press release of September 16, 2008, which does not provide an answer to this basic question about the transaction. Also on September 16, 2008, AIG filed a Form 8-K that essentially contained the same information as the Fed’s press release.
But then, in compliance with its ongoing disclosure requirements, AIG filed another Form 8-K on September 22, 2008, when the final agreements were executed. That filing provided copies of the executed agreements. And, in Exhibit D, we have, at last, the basic terms of the warrants. We paid $500,000 to purchase 80% of AIG on September 16, 2008.
It could be argued that public company disclosure requirements aren’t useful in the federal government context, since no one is trying to buy or sell shares in the Fed or the US Treasury (yet!). But a mandatory disclosure regime can provide benefits beyond improving the share price accuracy of the disclosing firm. Disclosures can enhance pricing accuracy for other assets in the economy, and requiring the disclosure of transactions between a firm and its agents is a nifty way to reduce agency costs.
Finally, requiring disclosure might also be an efficient way to reduce fraud. In an experiment published this summer in the Journal of Empirical Legal Studies, titled “Brandeis’ Policeman,” we found that, even when there are essentially no accountability mechanisms in place, disclosure requirements can reduce fraud. In our experiment some of the participants were required to provide a brief explanation for their activities. The participants that were required to provide this minimal amount of “disclosure” proved to be dramatically less willing to engage in fraud-like behavior.
The only question now is where the SEC will need go to file its own 8-Ks.
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1. Posted by Bill Sjostrom on October 9, 2008 @ 16:46 | Permalink
My guess is that the disclosure on AIG was sketchy because all the details of the deal were not hashed out when it was announced due to the exigent circumstances. Perhaps that is why it was initially reported that the Fed was getting warrants when they ended up getting preferred stock. See here. And don't forget that the treasury is subject to the FOIA. See here.
2. Posted by Mike Guttentag on October 9, 2008 @ 21:12 | Permalink
Bill. I agree with you on the facts, but think the points you raise support my claim that the Fed and the Treasury need to reconsider their disclosure policies during this crisis. The initial announcements from both the Fed and AIG were incomplete, but it was only AIG that distributed the actual agreement as executed a week later. Shouldn’t the Fed have done the same?
I recognize that we have system that allows for access to government records, but it was not a system designed to provide ongoing material disclosure. Is the FOIA really the best disclosure regime for the current activities of the Fed and the Treasury?
3. Posted by Taxrascal on October 11, 2008 @ 18:41 | Permalink
no one is trying to buy or sell shares in the Fed or the US Treasury (yet!)
It would actually be really helpful for them to sell, say, a 1% interest in the future income from the bailout. It would be a very simple way to judge their performance, and it would give them immediate feedback on whether plans they announced implied a positive or negative outcome (so if after they say they'll take equity in banks, that 1% increases in value to $8 billion, they know to go ahead).
Even better, the bailout-slices would be much more liquid than the underlying securities, so a company that owned such securities could short bailout-units instead of selling more.
It'll never happen, of course (though with short positions in index puts and muni insurance, and long positions in GE and Goldman, Berkshire Hathaway keeps getting closer). Fun thought experiment, though. And 8-K's would be a great start!
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