January 03, 2015

Beware of excessive information. (Blissful) ignorance is a potent driver of financial markets and of human activities.

Sir, Tracy Alloway describes the possibility of adding on, as you go along, new pieces of information that will enhance the knowledge of the risks, for instance in securities backed with residential mortgages, “New mutations beckon for system that shares DNA of each loan’s risk” January 3.

And Alloway quotes David Walker of Marketcore saying “This could be very disruptive, because not everybody is for transparency and accountability. Even if they say they are publicly, they may not be privately.”

It is worse than that! If risks were perfectly known, the price of the securities would reflect this and so there would be little profits to be made trading these, and so perhaps there would be no Wall Street. It is imperfect information that has prices zigzagging, which induces market participant to get out of bed in order to sell the not-too-well-perceived risks and buy the not-so-real-safeties.

In other words, ignorance is one of the most potent drivers of financial markets and human activities; and is therefore quite often characterized as quite blissful… at least by the winners.

But the worst that can happen with excessive information, that is when we, because of it, become convinced that we know it all. Like when bank regulators caused our banks to follow excessively the credit risk perceptions issued by some few human fallible credit rating agencies. Clearly some more information (and humility) about our ignorance would have come in handy.