March 11, 2009

Radical Transparency Now!

Wired has an interesting piece on what steps need to be taken to make Wall Street more transparent to help avoid another economic collapse:

That's why it's not enough to simply give the SEC—or any of its sister regulators—more authority; we need to rethink our entire philosophy of regulation. Instead of assigning oversight responsibility to a finite group of bureaucrats, we should enable every investor to act as a citizen-regulator. We should tap into the massive parallel processing power of people around the world by giving everyone the tools to track, analyze, and publicize financial machinations. The result would be a wave of decentralized innovation that can keep pace with Wall Street and allow the market to regulate itself—naturally punishing companies and investments that don't measure up—more efficiently than the regulators ever could.

Part of the current problem is the information is available, but in an inaccessible form. The lack of a standard reporting format is preventing functional transparency.

An interesting solution to this problem (which I hadn't heard of before this article) is XBRL. In short, XBRL allows for anybody to scan through reports produced by financial institutions without having to worry about the differences between two particular documents.

The SEC is going to mandate that all companies with market caps greater than $5 billion use XBRL to report their information by this June and eventually all companies will be required to report to the SEC in XBRL by 2011.

Before the move to XBRL it used to take 70 days to go over a bank's quarterly financial information. Now it takes two days.

Transparency won't just help large financial institutes. The article also talks about LendingClub, "a Web site that matches individual lenders with borrowers who need loans." What makes this site so different from other lending solutions is that it is largely open and transparent. Where as commercial banks keep their formulas under lock and key to develop a competitive edge, LendingClub "crowdsourced" their formula used to determine risk to the community and asked for suggestions and tweaks. The result?

All this innovation benefited not just individual lenders but the entire ecosystem. LendingClub's default rate is a staggeringly low 2.7 percent (versus nearly 5.5 percent for prime credit cards).