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The biggest shock for me in the recent financial crisis is realizing how little transparency we really have into the risks being taken by the businesses that form our stock markets.
It's becoming clear that the source of this crisis was that the lending industry was taking on more risk than they were being paid to take on. Every layer of the food chain (bond rating agencies, CDS writers, MBS packagers, loan officers, home appraisers) tended to sweep the default risks under the rug while taking their fees for supposedly protecting against those risks.
In the past the word transparency meant knowing that all cash flows were accounted for, that there was no cash leaking out via corruption. I'm sensing that now transparency has to mean something more; there needs to not only be transparency of cashflow but also transparency of risk and complexity.
With the immense scale of today's big corporations, with global markets and instant computerized money transfers, it's becoming clear that just knowing the exact account balances at the end of the quarter isn't enough.
The new way of stealing money is in plain sight, using complexity. Make a legal wrapper (such as MBS or CDS) that is so complicated and novel that nobody else has the time or inclination to unravel what is underneath, and you effectively have cover to do whatever greedy or morally bankrupt activities you want. Because the waste product, increased risk, doesn't show up on the balance sheet immediately, it builds up unseen until a leak springs.
It's almost like using public key cryptography; the person who built the wrapper has the key so they can see inside, and theoretically anyone with a sufficiently powerful computer can crack it from the outside. But in practice it's sufficient for most people to hide most anything successfully.
I'm worried that these "complexity wrappers" will be more and more common in the future, as computerized systems and globalization make them easier to construct and work with.
I don't invest internationally precisely because of corruption. There may be great economic opportunities overseas, but it seems to me the people on the ground and inside the deals are the ones who will sop that up in the form of bribes to the governments, warlords, mafias, insiders, and so forth. Rarely do the people in charge on the ground have motivation to make sure foreign shareholders are compensated for their investments; the banana republics and warlords tend to have very short term orientations, not caring if their reputations with overseas investors are soured by corruption. You can say lots of bad things about the US financial system, but you can't say we don't care about our reputation. US treasuries are still considered one of the safest places to stash money.
If I were investing internationally, I might be concerned by revelations of the recent financial crisis; I might decide that I want more transparency than I can get overseas, and that for all the US flaws at least we're the ones that first found and first started fixing this global problem. And I might be concerned that overseas investments are sinking right along with the US; the supposed diversification advantage of overseas is not helping much now.
But I do have the contrarian in me saying maybe now is a good time to diversify into overseas indexes just because they are down and I'm not in them.
I'm curious to hear from others on whether the financial crisis revelations have changed your appraisal of overseas investing, especially as it relates to transparency and corruption. Are you increasing, or decreasing your international allocation these days and why?
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