Subprime mortgages allow people of limited means to obtain loans for outsized amounts of money. It sounded too good to be true and, sadly, it was. When Standard & Poor's, one of America's major rating agencies, discovered in mid-2006 that over 40 per cent of these mortgages were ending in default, it began slashing ratings for bonds based on them. But many investors were already in the game for a lot of money.

Mainland Chinese banking authorities immediately sought to downplay the liabilities for the nation's institutional investors. 'Mainland banks' holdings of subprime debt are relatively small, the credit ratings of their bond holdings are generally high and there is a risk-management system in place, so any direct losses are limited,' said Liu Chunhang, of the China Banking Regulatory Commission's Research Department, in an interview carried by Xinhua.

But, in many cases, the investments' ratings themselves are the trouble. In the past five years, each of America's big rating agencies - Standard & Poor's, Fitch and Moody's Investors Service - has made large profits by rating bonds comprised of subprime mortgage debt. The Wall Street Journal reports that these agencies earn twice as much by rating mortgage securities compared with other securities, because it requires more time and analysis.

So a perverse sort of symbiosis developed, in which the agencies were implicitly called on to give higher ratings than they should have to securities based on new types of mortgages without established track records. There's nothing wrong with taking more money to rate certain types of securities, but it becomes a problem when a lack of transparency prevents investors from learning of potential conflicts of interest. The agencies should have disclosed the extent of their reliance on subprime bonds. In free markets like that of the US, when investors find out the companies they're investing in are taking on unacceptable amounts of risk, they can pull out their money. So the companies' executives, who are often paid for performance, have an incentive to limit liabilities, keep the public informed and maintain investors' trust.

In mainland China, that's not always the case. Though publicly traded, the BOC is still majority-owned by the investment arm of the state-owned People's Bank of China. This presents transparency problems. The Royal Bank of Scotland and other private investors own a substantial minority of BOC. But, being minority stakeholders, they cannot ensure that the bank's managers keep them apprised of its holdings or strategic thinking.

That adds an element of risk, and makes other would-be investors think twice before casting their lots in with mainland financial institutions. Xinhua's official response to the revelation that BOC held substantial investments in subprime debt, published last Saturday, led with the fact that Standard & Poor's hadn't lowered its rating for BOC as a result. But, as western investors now know, the ratings themselves are suspect.

In contrast to stories in the Associated Press, the South China Morning Post, the Financial Times and many other sources, Xinhua's report didn't seem to address the severity of the situation and, consequently, it didn't shore up investors' confidence. It may have made them think the reality was even worse than authorities admitted.

When bad news breaks about companies, Americans and other western investors are culturally inclined to expect them to admit some sort of guilt in an effort to restore their credibility. The BOC management has long since decided to avail itself of the benefits of foreign investment. But it must persuade outside investors that it's a good bet. Eventually, that will mean conducting affairs more transparently.

As US firms know all too well - and as the BOC and its managers may be learning - any investor is going to make mistakes from time to time. The strength of free markets is that, by allowing individuals to invest in whatever they choose, they can spread risks more thinly over large numbers of people, and minimise the impact of potential crises. In order for that to work, however, investors have to know the risks they're bearing. So, in the end, free markets can't operate without free presses.

David Donadio is a writer and editor at the Cato Institute