Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Gorton defends opacity of the plutocrats

Gary Gorton has published a paper on “The development of opacity in U.S. banking” (NBER working paper 19540, October 2013). He writes that before the US Civil War:

… bank note markets functioned as “efficient” markets; the discounts were informative about bank risk. Banks at the same location competed, and the note market enforced common fundamental risk at these banks.

Then bank notes were replaced by checking accounts, the banks were taken over by rich men who kept the price per share high enough to keep it out of reach of most investors thereby effectively closing down the market for their stocks. Simultaneously,the clearing houses brought about a culture of secrecy so that depositors also knew little about the health of individual banks.

Gorton thinks that this shutdown of informative and efficient markets was a great thing for economic efficiency – a claim that I find difficult to believe.

On the other hand, the endogenous opacity that Gorton describes is completely analogous to the conclusion of another recent paper (“Shining a Light on the Mysteries of State: The Origins of Fiscal Transparency in Western Europe” by Timothy C. Irwin, IMF Working Paper, WP/13/219, October 2013) on the opacity of sovereign finances:

When power has been tightly held by a financially self-sufficient king, much information about government, including government finances, has remained secret. When power has been shared, either in democracies or sufficiently broad oligarchies, information on government finances has tended to become public.

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