These days, transparency is a financial buzzword. Opening the curtains on the operations of financial markets is supposed to help investors and regulators make better decisions.
But sometimes, transparency can backfire, according to new research from Michael Sockin , an associate professor of finance at Texas McCombs. Sockin modeled two kinds of financial markets — for corporate bonds and short-term lending — and found that less transparency can lead to better economic outcomes.
Too much public information about those markets can lead companies to undertake riskier investments, he says, which can trigger repercussions such as in the 2008 global financial crisis.
"Having this extra data is not necessarily a good thing," he says. "The spillover effects can include more corporate defaults and more losses for investors. In turn, that creates problems for insurance companies or pension funds."
At the heart of Sockin's study are markets for repurchase agreements — known as repo markets — which function as pawnshops for securities. Institutional investors such as insurance companies and pension funds raise short-term cash by selling securities to repo lenders. After a short period — from overnight to 28 days — they buy back the securities at a higher price, letting the lender pocket the profit as a lending fee.
Repo markets are the "plumbing of the financial system," helping institutional investors buy and hold corporate bonds, Sockin says. In turn, that helps corporations raise capital for new projects. Though largely invisible to the public, they average over $12 trillion in loan exposure every day.
