Transparency is integral to a responsive, accountable, and ultimately functioning government, but it is also a vital component of a functioning economy. Indeed, a number of federal institutions exist to ensure that depositors, lenders, and borrowers have access to relevant financial data that allows them to engage in mutually beneficial transactions. The Obama administration's financial regulatory reform proposal acknowledges the important role that transparency plays in the economy's financial sector and contains a number of measures to increase transparency in the notoriously opaque financial system.

The financial industry is the sector that allocates capital to the rest of the economy; that is, it pools, pipes, and pumps money from investors to businesses that make the goods consumers buy. If investors cannot trust those to whom they would lend funds, then businesses could not function. It is here that regulation becomes necessary, as federal institutions serve as enforcers of the rules that inculcate trust in the system. And at the heart of financial regulation are those rules designed to enhance transparency in the financial market. Indeed, the Securities and Exchange Commission (SEC) functions by providing "a common pool of knowledge for all investors" because "[o]nly through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions."

While there were many events over the past few years leading to the near-collapse of the financial system, the opacity of several sectors places them on a likely list of suspects. The financial crisis has its roots in investors from all around the globe, searching for low-risk, high-yield vehicles in which to invest. Discovering what they believed at the time to be such low-risk investments, they began purchasing massive quantities of securities based on the value of residential mortgages (e.g., collateralized debt obligations [CDO], residential mortgage backed securities [RMBS], etc.). It turned out, however, that many of the underlying mortgages in those securities were issued fraudulently, incompetently, and willfully ignorantly.

As a consequence of reckless lending decisions, mortgage-backed securities lost significant value and decimated the balance sheets of the firms that owned them. Critically, potential lenders refused to extend credit to them, because creditors had no idea if those firms would be able to stay in business to be able to repay the loans. In every step of the process, inaccessible information contributed to poor decisions by investors and stymied inter-business lending.

When firms were purchasing CDOs, they believed (or could plausibly claim they believed) they were making risk-free investments, because credit rating agencies (CRAs) – the private entities that grade the riskiness of debt instruments – judged the CDOs to be so. The CRAs failed spectacularly in their assessments. Understanding the methodologies behind the CRAs' ratings and disclosing details of the financial ties between CDO issuers and CRAs might have exposed failures in the securities rating systems, giving pause to potential purchasers.

The financial regulation proposal put forth by the Obama administration would increase transparency in and strengthen oversight of CRAs. Crucially, the proposal also recognizes the role that lack of transparency played in the financial crisis and the need for increased transparency in broader financial regulatory reform.

According to the proposal:

Securitization, by breaking down the traditional relationship between borrowers and lenders, created conflicts of interest that market discipline failed to correct. Loan originators failed to require sufficient documentation of income and ability to pay. Securitizers failed to set high standards for the loans they were willing to buy, encouraging underwriting standards to decline. Investors were overly reliant on credit rating agencies. Credit ratings often failed to accurately describe the risk of rated products. In each case, lack of transparency prevented market participants from understanding the full nature of the risks they were taking.

In a recent speech on Wall Street, Obama laid out his plan to fill in these information gaps (a detailed description of the proposal is available here). The speech came as the House Financial Services Committee, chaired by Rep. Barney Frank (D-MA), began holding hearings on financial regulatory reform. The committee will likely spend a good part of October holding hearings and conducting markup sessions as the members try to reconcile the administration's plan with many other financial reform plans. However, since Frank currently supports Obama's reform proposal, it appears likely that this plan will receive the most attention.

Obama's plan is divided into five parts:

• Supervision and regulation of financial firms
• Comprehensive regulation of financial markets
• Consumer and investor protections
• Government financial crisis management tools
• Coordination of international standards

Each plank of the plan seeks to address a perceived failing of the financial system that contributed to the current economic crisis, and improving transparency plays a role in the first three major areas.

The first part, the regulation of financial firms, would have the greatest impact on the financial system. The administration would create several new agencies, including the Financial Services Oversight Council (FSOC) and the National Bank Supervisor (NBS). The NBS would combine national banks' federal savings association supervisors, in an effort to prevent regulatory shopping. At the same time, the Federal Reserve would step up its regulation of bank holding companies. The FSOC would serve to coordinate all financial regulation in an effort to prevent regulators from ignoring sectors of the market. Additionally, the FSOC would "facilitate information sharing and coordination among the principal federal financial regulatory agencies regarding policy development, rulemakings, examinations, reporting requirements, and enforcement actions."

As the second plank in its plan, the administration would strengthen the SEC. Noting that "over the counter derivatives" such as credit default swaps, which ultimately caused the $70 billion bailout of insurance giant AIG, were "a major source of contagion through the financial sector during the crisis," the proposal seeks impose new record keeping and reporting requirements on these financial instruments. Additionally, the plan states that "[i]nvestors and credit rating agencies should have access to the information necessary to assess the credit quality of the assets underlying [opaque financial instruments]." And while this section of the plan encourages the SEC to impose more transparency requirements on CRAs, it would not result in new legislation to mandate such rules. Rather, it would leave to the SEC discretion as to which transparency regulations to implement.

The third part of the plan would protect financial consumers by creating the Consumer Financial Protection Agency (CFPA), a sort of financial services version of the Consumer Product Safety Commission. The CFPA, which would "make sure that consumer protection regulations are written fairly and enforced vigorously," would protect consumers from hazards such as sub-prime mortgages. The CFPA would also have a key transparency role, in that it would have the power to require clear and reasonable public disclosures of financial services companies.

The fourth and fifth sections of the reform proposal are somewhat less developed than the other three. The fourth plank pledges that, next time around, the government will have a tool to address "too big to fail" institutions, but it remains unclear what kind of tool that will be. The fifth plank is a vague promise for "international cooperation," which is intended to help prevent another global financial collapse.

The Obama proposal highlights the "lack of transparency [that] prevented market participants from understanding the full nature of the risks they were taking." Indeed, elements of the proposal will take big steps toward filling the information gaps that helped precipitate the financial crisis by mandating the financial services sector to disclose more information. The government will provide much needed transparency while also regulating the most risky financial products. This new level of transparency is warranted, as it will protect not just investors and other players in the financial services industry, but also the millions of Americans who depend on a functioning financial system that allows the economy to grow.