The Mystery of Capitalism by Hernando De Soto.

I posted a blog about this book on SERENE™ back in January 2007 which is worth repeating in part:

Hernando De Soto, makes a very good case for private ownership of property as the engine of any economy. Without having documented proof of property ownership entrepreneurship would be impossible. Over 80 percent of all businesses in this country are started because the home served as collateral.  He says:

This wasn’t always possible. After the California gold rush there were about 800 separate property jurisdictions, each with its own laws. Outside each jurisdiction a property did not “exist”. It was without value. The earlier squatters who occupied land did so outside the formal legal system. It took several decades to create the nation-wide formal legal ownership of property that can be documented through title.

I’ve bolded in the above the word “documented” to emphasize the missing characteristic of the newly-minted financial instruments known as derivatives — mortgage-backed securities, collateralized debt obligations, and credit default swaps.

Not surprisingly, De Soto’s commentary in the WSJ picks up where his book leaves off:

These derivatives are the root of the credit crunch. Why? Unlike all other property paper, derivatives are not required by law to be recorded, continually tracked and tied to the assets they represent. Nobody knows precisely how many there are, where they are, and who is finally accountable for them. Thus, there is widespread fear that potential borrowers and recipients of capital with too many nonperforming derivatives will be unable to repay their loans. As trust in property paper breaks down it sets off a chain reaction, paralyzing credit and investment, which shrinks transactions and leads to a catastrophic drop in employment and in the value of everyone’titles property.

In other words, what has taken us centuries to develop, which is the documentation and categorising and registering of ownership of real property (title) has been willfully ignored by the people who’ve invented these derivatives.

In De Soto’s own words, his WSJ article says:

Ever since humans started trading, lending and investing beyond the confines of the family and the tribe, we have depended on legally authenticated written statements to get the facts about things of value. Over the past 200 years, that legal authority has matured into a global consensus on the procedures, standards and principles required to document facts in a way that everyone can easily understand and trust.

The result is a formidable property system with rules and recording mechanisms that fix on paper the facts that allow us to hold, transfer, transform and use everything we own, from stocks to screenplays. The only paper representing an asset that is not centrally recorded, standardized and easily tracked are derivatives.

(Emphasis mine).

De Soto does not believe the solution to the current crisis lies in “clinging to the hope that the existing market will eventually sort things out.” What is the market to sort out if the market does not know who owns it, much less what “it” is worth?

“Modern markets only work if the paper is reliable,” De Soto concludes.

As a Realtor® I know this only too well. Documentation of ownership and value are critical to every real estate transaction. Cloud on title is a bad thing.

The cloud that darkens most of these derivatives needs to be lifted before we can see our way out ot this mess.