By Simon Kennedy and Matthew Benjamin

Jan. 27 (Bloomberg) — When it comes to transparency, the world’s bankers won’t surrender without a fight.

Even with capitalism suffering its biggest crisis since the Great Depression — a meltdown born and nurtured in opaque markets from subprime mortgages to credit-default swaps — the bankers gathering with politicians in the Swiss resort of Davos this week may be unwilling to allow too much sunshine into the dark corners of their business.

“The financial system will kick back against transparency,” says Joseph Stiglitz, the Columbia University economist and Nobel Prize winner who’ll be in Davos.

“Those working in markets see information as power and money, so they depend on a lack of transparency for success,” says Stiglitz, who won his Nobel for research on information asymmetry — what happens when one party in a transaction has access to knowledge that others don’t.

The resistance may set up the ultimate test of strength between markets and governments, dictating the future of the world economy. As the global slump deepens, and President Barack Obama promises to exert a “watchful eye” over the financial system, the risk is new rules won’t be strong enough to stop banks repeating history and circumventing them.

Toothless

“Without teeth, the banks will roll right over this stuff in a couple of years,” said Roy Smith, a former partner at Goldman Sachs Group Inc. who has attended Davos in the past. “Wall Street’s filled with a lot of big guys. They know how the bread gets buttered, they know how to play the game.”

Bankers, once hailed as Masters of the Universe, return to the seminars and parties of the World Economic Forum’s annual meeting chastened by losses and writedowns that top $1 trillion. Deutsche Bank AG Chief Executive Officer Josef Ackermann, who said two years ago that many investment banks “have a very good future,” reported a record loss in the fourth quarter.

Some won’t be back at all. Former Merrill Lynch & Co. Chief Executive Officer John Thain, originally slated to be in Davos this week, lost his job on Jan. 22. A year after Lehman Brothers Holdings Inc. head Richard Fuld sat on a panel discussing sovereign wealth funds, his bank no longer exists.

Power Pendulum

Policy makers are now tightening their grip on the financial system. Timothy Geithner, Obama’s pick for Treasury Secretary, last week called for “comprehensive” regulatory changes. British Prime Minister Gordon Brown’s government has bought stakes across the banking industry and European Central Bank President Jean-Claude Trichet is pumping unlimited funds into the money markets.

“The pendulum of power has swung from financial institutions to politicians,” says Morgan Stanley Asia Chairman Stephen Roach, who was among the first to raise the specter of global recession at last year’s conference.

Obama will be represented by White House adviser and confidante Valerie Jarrett at the five-day conference, which starts tomorrow and is titled “Shaping the Post-Crisis World.” She will join Trichet, Brown and more than 2,500 other executives, officials and government leaders.

More Light

One of their main pushes will be to illuminate the murkier market practices that evolved during the boom. Banks pushed more and more of their investments off their balance sheets and beyond the reach of capital requirements. At the same time, subprime mortgage loans were repackaged into derivatives and became toxic as rising interest rates sparked a wave of defaults.

Obama wants to strengthen capital requirements on mortgage securities and derivatives and force banks to better disclose the assets they hold. U.K. officials are pushing for similar measures and Trichet’s ECB is angling for a bigger role in monitoring banks.

One of the problems for governments is that new securities laws are often so complicated that legislators need help from industry to craft them.

“The complexity of the legislation works in the industry’s favor,” says Paul Mahoney, a regulation scholar at the University of Virginia. The thrust of new regulations might be against banks, “but when it gets time to get the details down on paper, they can have real influence.”

History

That problem is almost as old as finance itself. In the 1690s, the dawn of share trading in London, brokers turned a government crackdown on short selling to their advantage. They persuaded Parliament to include in the new rules a ceiling on the number of legal brokers to 100, effectively locking rivals out of the system.

Franklin Roosevelt’s Truth in Securities Act, signed into law in 1933, met a similar fate. Aiming for better disclosure in the aftermath of the 1929 Wall Street Crash, the law ultimately helped major banks by freezing the existing underwriting system in their favor, says Mahoney.

Financiers are already lobbying. While they acknowledge greater transparency has its virtues — they’ve accepted the idea of an additional regulator for derivatives — they want to preserve the potential for profits and warn that too much disclosure risks confusing markets.

“Flooding investors with a lot of disparate information can be misleading,” says Charles Dallara, managing director of the Institute of International Finance, who will be in Davos. His organization represents more than 300 financial companies.

Flashpoint

Another flashpoint is so-called fair-value accounting, which requires companies to record assets every quarter to reflect market value. The idea is to give investors a better estimate of a company’s worth.

Bankers such as William Rhodes, senior vice chairman at Citigroup Inc. and a Davos delegate, say the standard is unfairly punishing during times of turmoil when buyers are scarce and assets become difficult to price.

Lawmakers must also avoid “going overboard with regulation” of hedge funds, billionaire investor George Soros warned Congress in November. “It would be a grave mistake to add to the forced liquidation currently dislocating markets by ill-considered or punitive regulations.”

How much light is ultimately cast on finance will show how much power governments have won over the market and the economy. While Harvard professor Ken Rogoff says “there’s going to be a sea change in transparency to match the crisis,” Stiglitz is “not very optimistic.”

“Many in the financial industry are ethically challenged and that has to be realized,” says Stiglitz. “What you don’t know is the source of Wall Street’s profits. The next crisis will also be about ‘if only we knew’ too.”

To contact the reporters on this story: Simon Kennedy in Paris at skennedy4@bloomberg.netMatthew Benjamin in Washington at mbenjamin2@bloomberg.net

Last Updated: January 26, 2009 19:01 EST