The March 25, 2009 edi­tion of The Wall Street Jour­nal (WSJ) car­ried one of the most lucid and log­i­cal expla­na­tions of the cause of our cur­rent finan­cial cri­sis. The arti­cle — Toxic Assets Were Hid­den Assets — was penned by none other than Her­nando De Soto whose book,  The Mys­tery of Cap­i­tal caught my atten­tion some two years ago.

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.