Wall Street fears the light

The fear in Wednesday's stock decline was palpable.

Wall Street was responding to the specter of transparency the way it always does — with alarm.

Big brokerage firms, led by Merrill Lynch and Lehman Bros., plunged after the nation's top securities cop called for more disclosure of Wall Street's finances.

The decline was the biggest in two months for financial stocks.

Securities and Exchange Commission chief Christopher Cox said his agency later this summer will require investment banks to make more capital and liquidity information public.

In other words, these publicly traded firms will have to give their investors a more accurate financial picture of what they're doing.

Those who own shares in investment banks have reason to worry.

The bright light of public scrutiny almost always costs Wall Street money.

It's an institution, after all, that profits most when it can exploit the ignorance of others.

Creature of the night

Wall Street prefers the dark, where it can control the information meted out to investors. It's no coincidence, after all, that market participation exploded with the advent of the World Wide Web , which made stock prices readily available with minimal delay to average citizens.

Nor is it surprising that companies such as Bloomberg became multibillion-dollar businesses by taking information once held exclusively in the dark hallways of Wall Street and making it available to those with money at risk.

In the 1970s, when the SEC forced Wall Street to disclose brokerage commissions, rates tumbled and Wall Street's profitability shifted to other businesses such as investment banking.

Something similar happened in the bond market.

As real-time pricing seeped in, investors could see the difference between their bids and the seller's asking price, known as the spread. The spread represented brokers' profit.

If you wanted to know the price of a municipal or corporate bond, you had to ask your broker.

You assumed he was giving you an accurate price and that he wasn't inflating the spread for his own benefit.

When pricing became more transparent, the spreads narrowed.

Information, after all, is the foundation of competition.

Worries no wonder

Is it any wonder, then, with Wall Street facing new disclosure demands over its finances that investors are worried?

Most investment banks provide some basic liquidity information in their quarterly financial statements, and some provide more detailed data to the SEC that the commission currently doesn't make public.

Cox's plan would require banks to disclose that information and provide more details about funding and capital ratios.

Eventually, firms also will have to reveal their concentrated exposure to key markets, he said.

For example, had the rule been in place this year, Bear Stearns would have had to discuss its vulnerability to the collapsing mortgage market.

International rules

Commercial banks already have to release this kind of data under the international standards by the Basel Committee on Banking Supervision , a 10-nation consortium of central bankers.

The Basel Committee is developing a new set of standards that would require similar disclosure from investment banks.

It's unclear whether better disclosure would have saved Bear Stearns.

Certainly, it would have given investors a clearer picture of what they were buying into.

Cox, of course, is on the defensive, facing questions from Congress and the investing public over the SEC's failure to head off Bear Stearns' demise.

Exposing time bombs

As the SEC stood on the sidelines, the Federal Reserve stepped in and brokered a fire sale deal to JPMorgan Chase, in part because it worried that Bear's failure would spark a cascade of financial institution failures that would reverberate through the short-term debt markets.

Cox's plan might not have prevented that, but it may have caused investors to question Bear's exposure to mortgage securities long before those holdings became fatal.

Who knows what other time bombs may be ticking on Wall Street's books?

What other financial risks have investment banks understated in the name of fast profits?

That's what Wall Street is worried about. When we turn on the lights, its party is over.

Loren Steffy is the Chronicle's business columnist. His commentary appears Sundays, Wednesdays and Fridays. Contact him at loren.steffy@chron.com. His blog is at http://blogs.chron.com/lorensteffy/.