The Value of Reliable Information

Rating agencies are widely discredited but from where are the new tools to evaluate securities riskiness expected t come from.
Until(as long as) we don't re-established the confidence we will not see many investment.Unemployment will grow and governments will face the kind of challenge from anti-system forces that for long time we have thought confined into a remote past.

We must face the problem as soon as possible and States, no matter if for lack of better suited actors, must take the lead.

What to do? Here's the flash forward to the answer of Mark Thoma:

"The solution to this problem, then, is to provide insurance against the risks caused by the lack of information during the time period when the information flows are being restored".

And here the analysis:

"Analysts writing about the credit crisis often have more certainty about the source of the problems in financial markets than I think is warranted. Thus, rather than advocating robust solutions, these analysts tend to come up with narrow answers to the problems they have identified. Yet evidence from previous crises suggests that America needs to take a broad approach to the current turmoil.
(...)
There may be a single key to unlocking the whole mess, but if there is we aren't sure what it is, and that also points to a multi-pronged approach. Capital injections are one part of that approach, but capital injections do not, by themselves, adequately address(...) all of the elements of the problem.

So where do the solutions that have been suggested come up short? If you read across the spectrum of serious proposals, and look at what has actually been implemented, most of the underlying problems have at least been recognised. But one area that has not received nearly enough attention is the information problem. Previous financial crises did not cause us to seriously question our informational architecture like this one has. This crisis has wiped out or discredited major sources of financial-market information that are crucial for credit markets to function. The ratings agencies are an obvious example. They are supposed to solve an asymmetric information problem between borrowers and lenders by giving those doing the lending a reliable assessment of the riskiness of financial investments. They failed in that mission.

Likewise, the balance sheets of financial institutions are no longer trusted—assessing a firm's solvency is largely a guess at this point. People are not going to part with their money until they are confident that the information about potential investments, and about the firms managing those investments, is reliable. That is true for both depositors and potential equity holders who could help with recapitalisation. We can take toxic assets off the books, but how will investors know for sure that new financial assets are safe, or that the firms doing the investing won't repeat the mistakes of the past and take huge losses yet again? How will investors know that the mathematical models used to assess these assets in terms of risk and return are reliable?

I don't think anything trustworthy can replace the ratings agencies in the short-run—nobody has much faith in the risk-assessment models being used in the industry—and that will be a problem as firms begin to issue new securities, a step that is needed to get credit flowing. There might be more we can do with respect to balance-sheet information, but this problem also seems to stem from the difficulty investors have in valuing financial assets.

The solution to this problem, then, is to provide insurance against the risks caused by the lack of information during the time period when the information flows are being restored. Private-sector agents may not want to risk putting their money into the banking system right now as equity holders if they believe they might lose everything. But if the downside risk is limited through some insurance provision—something that puts a limit on losses—they might not be so reluctant (and government may be the only one capable of such guarantees). Similarly, private-sector agents may be unwilling to invest in financial assets, or to trust money managers if they believe their money can suddenly disappear. Again, though, if the downside losses are limited, they might not be so reluctant. There are many, many forms this type of insurance can take, and the solutions can be based in both the public and private sectors. The important thing is to get the insurance into place.

So my recommendation would be to continue to pursue a broad-based strategy that addresses the many problems that have been suggested as potential causes of the crisis, and to bolster the initiatives that help to overcome the information and credibility issues that have arisen as big barriers to the flow of new credit. On the information and credibility issue, it's important to recognise that even if we recapitalise every bank that is in trouble, remove every existing toxic asset on every bank balance sheet, and refinance every mortgage so that it is not in danger of default, we still will not have fully repaired financial markets. We will still be left with a lack of trust—for good reason—in the informational architecture people use to make financial decisions. Until that is repaired—which will require a new regulatory structure, among other things—these markets will not perform to their full potential without some sort of insurance against the lack of credible information