Credibility, Failure of Disclosure, Financial Crisis

I was thinking about the question I raised last time: what happens if no one knows anything but investors have crazy belief that some one (e.g. large financial institutions) must know something?  And I am wondering whether it be one suspecter of the financial crisis?

Information theory shows us that disclosure may mitigate the information asymmetry problem and improve efficiency.  However, an embedded assumption is that the disclosure is credible.  What if no one or some one just does not believe what have been disclosed?  It could be that the firm who makes the disclosure is indeed a trouble firm and gives faked information and/or the regulation is not under-developed and could not detect it for the investors.  Or it could also be that the investors can neither believe the firm or the regulator due to their dirty history.  In this case, disclosure is nothing good but a waste of money because it is usually costly.  As a result, disclosure destroys value ex-post, although, ex-ante, firms disclose in the hope of improving efficiency.

I suspect that this situation happened in the recent financial crisis, at least to some level.  The government thought they are doing their job, to force mandatory disclosure and to encourage voluntary disclosure, so that market is becoming more efficient.  But some investors do not believe those any more, because there were too many scandals in the history: Enron, Worldcom, ...... Now even government can default: Iceland, and Greece almost...... Then what?  It is difficult to tell who is telling the truth nowadays, and disclosure could sometimes fail.  The failure of disclosure could bring even bigger disaster than information asymmetry itself because the firms and the government may not be aware of the possibility of the failure of disclosure and disclosure is itself costly.

The worst thing is not that you find a weakness of yours because you can then do something to improve it, is that you have a weakness but you just do not know it or do not want to admit it, yet.