For hundreds of years, the United States and Europe gathered and classified all that paper in publicly accessible records, from deeds and registries to balance sheets. Originally created for recording ownership, these data systems were gradually adapted to serve all legal interests and relationships linked to property. Credit and debt could be measured, risk and potential inferred. Matching capital and finance to property made it easier for liquidity to move in step with the general interest. This knowledge served the West phenomenally well: Since World War II, Western economies not only avoided major contractions but also grew more than in the previous 2,000 years.
Until 2008 — when we found that those systems had stopped telling the truth.
TARP authorities couldn’t locate knowledge about toxic assets fast enough because so many non-standardized types of records were scattered around the world. U.S. property and mortgage transactions records became obscured when companies were permitted to raise large amounts of financing by “bundling” mortgage loans into marketable liquid securities and recording these “derivatives” not with the traditional public registries but with the Mortgage Electronic Registration Systems, a private company whose registry reportedly holds about half the mortgages in the United States.
These derivatives had a notional value of $600 trillion to $700 trillion — 10 times the amount of global annual production. They are still outside any property memory system.
After hundreds of years of clear, reliable information on balance sheets, newer policies allowed companies to engage in off-balance-sheet accounting, effectively permitting them to appear more profitable than they really are. Information on debts is passed to the ledgers of “special-purpose entities” (SPEs) – think Enron, which had more than 3,000 SPEs — or swept into illegible footnotes. More broadly, national balance-of-payments accounts were supposed to signal facts regarding financial capital and transfers and debt. Yet no one saw the Greek or Italian sovereign debt crises coming because governments made their fiscal status look rosy by using new financial devices to swap their debts in one currency for another. An old debt looked like an inflow of new money.
We reformers in emerging economies have struggled for the past two decades, as Bernanke noted, to get our people and their assets onto the books, searching for and — whenever possible — incinerating fictitious capital to bring swarms of citizens living in economic anarchy under the rule of law.
We learned this from you, that the main source of credit is not money but the “moneyness” of property documentation. All financial activity must be documented if trust is to be regained in paper and, ultimately, in markets.
Hernando de Soto, a Peruvian economist and the author of “The Mystery of Capital,” assists governments in Africa, Asia, Latin America and the Middle East in their efforts to create market economies.
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