Famed economist Hernando de Soto has an interesting reinterpretation of the financial crisis in the latest issue of Business Week. He sees economic development over the 19th and 20th centuries as an effort to establish shared facts. “The result,” he writes, “was the invention of the first massive ‘public memory systems’ to record and classify — in rule-bound, certified, and publicly accessible registries, titles, balance sheets, and statements of account — all the relevant knowledge available, whether intangible (stocks, commercial paper, deeds, ledgers, contracts, patents, companies, and promissory notes), or tangible (land, buildings, boats, machines, etc.). Knowing who owned and owed, and fixing that information in public records, made it possible for investors to infer value, take risks, and track results.”
But “over the past 20 years, Americans and Europeans have quietly gone about destroying these facts.” We have giant derivatives markets that go largely untracked and unregulated. There’s little good information on the “repo” market where most big players manage their money. The mortgage-tracking system has fallen apart. And de Soto is not confident that the Dodd-Frank financial reforms go far enough to fix this:
Dodd-Frank has sought to move derivatives into clearinghouses where more data about them can be collected. It’s a step in the right direction. But if you believe in the value of public memory and economic facts, the reforms leave a number of problems outstanding.
First, various groups of derivatives end users, such as nonfinancial companies and sovereign wealth funds, are likely to be exempted from the clearing process—from 40 percent of them, according to Craig Pirrong of the University of Houston’s Bauer College of Business, to 70 percent, according to Michael Greenberger, a former Commodities Futures Trading Commission director. Second, the information collected would be available only to regulators because certain business data are considered “proprietary.” Third, the $700 trillion worth of derivatives that ignited the recession are not covered by Dodd-Frank. Warren Buffett successfully lobbied for their exclusion, saying it would be tantamount to rewriting old contracts and would force healthy derivatives players such as his own Berkshire Hathaway to post collateral on old deals. Fourth, the clearing system is not likely to be fully operational for another 5 to 10 years. Fifth, many clearinghouses do not have the kind of complete information required by traditional public memory systems: incentives for recording that asset owners can’t resist; standard classifications to facilitate identifying and governing the assets; universal access to the information; integration or linkages with other recording systems; provisions to protect third parties from negative externalities; identification of all asset holders and interested parties; limited liability provisions to improve accountability.
As he goes on to say, “that’s a lot of failure to digest in a single paragraph,” so it’s worth reading the whole piece to see it unpacked.