Explanations for the recent meltdown in global credit markets that destroyed tens of trillions of dollars of financial wealth are as plentiful as the sub prime mortgages that are often blamed for the crisis. A short list would include: complexity, size, deregulation, derivatives, bad financial models, black swans, ratings agencies, fraud, greed, CEO pay, originators, investment banks, commercial banks, and more. The problem is not that any of these is right or wrong; it is that they lack a systematic institutional framework to help parse out good explanations from bad. And without solid explanations, good policy responses are impossible.
We propose examining a related financial system, equity markets, that had what we describe as a “good equilibrium” one in which large and small investors were willing to invest long term because there was a secure mechanism for generating high quality information about the financial instruments offered for sale. We argue that this mechanism was driven by an unusual and little studied institutional structure, the nonprofit member organization.
We describe a “hostage” mechanism within the nonprofit New York Stock Exchange (NYSE) before it demutualized in March 2006, and find empirical evidence for the presence of this mechanism using bid-ask spreads as a measure of information quality. We then argue that this mechanism, was absent from the mortgage backed securities market where the credit crisis likely started, possibly because the type of protective institutional structure that could have prevented financial disaster is difficult to replicate.
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PDF Ebook Using Hostages to Improve the Quality of Financial Disclosure and Financial Institutions
