Sep 22, 15
[C]onsider the way de Beers sells wholesale diamonds. They place the diamonds in packets that buyers are forbidden to explore. The packets are sold on their gross attributes on a take-it-or-leave-it basis. If buyers were allowed to look into the packets first to a get a better estimate of their value, packets left behind would become tainted. Inspection would slow down trade and might even prevent trading entirely. Placing diamonds in packets eliminates adverse selection among buyers. Similar problems between de Beers and the buyers are, in turn, eliminated by de Beers’ concern for its reputation, supported by its monopoly rents and by repeat buying. …[F]ar from being a problem, lack of transparency enhances market liquidity.
Today’s repo markets, which play such a prominent role in shadow banking and also in the crisis, are close cousins of pawn brokering with similar risks for the parties involved.