Clear and Simple

For months I’ve been reading articles about how we got into our current financial mess, and listening to really smart economists discuss its origins. One common theme is that even the smart people who created these derivatives and CDOs etc. didn’t really understand them. Clearly they didn’t understand the potential risks.

So to prevent this happening again I suggest that all such deals in the future must pass CAST, the Clear and Simple Test.

Some ideas for how it might work:

CAST would limit documents to a few pages in length.
CAST would clearly state potential risks.
CAST documents would be written in plain English. Documents which can only be understood by lawyers and accountants fail the CAST.

You get the idea.

Requiring that financial deals pass CAST would certainly take a lot of the creativity out of Wall Street. (This doesn’t sound like a bad idea.)

Deals might sound more like this:

I’ll loan you $500 for a year. At the end of the year, you’ll owe me $550. If you don’t pay me, you give me permission to come over to your house and take $750 worth of your stuff (snowblower, bicycles, whatever).

Now imagine your town or school district wants to borrow 30 million dollars to invest in some complex financial instruments which are described in a 300 page closing document. The broker offering you this deal tells you that you’ll get a 2% return (which you hope to use for pensions, or local infrastructure, or whatever) and assures you that it is a very safe investment.

I don’t know about you, but I can, if I have to, plow through 2-3 pages of legalese and, just maybe, have a general idea of what I’m being asked to sign. 300 pages? Not a chance—life is too short.

So rather than struggling, the town manager or school board members tell the broker to come back with a CAST acceptable document. If the broker can’t do it, then clearly the deal was a bad one. Whew! If he does come back, they read the new description and see if it fits their needs.

And how about laws? Wouldn’t CAST eliminate a lot of the sneaky stuff that is hidden in 1,000 page bills passed by Congress?

I’ll end with this quote:

The price of clarity, of course, is that the clearer the document the more obvious its substantive deficiencies. For the lazy or dull, this price may be too high.

* Reed Dickerson, Professor of Law, Indiana University.

Quote Source