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.

Almost as inevitable as death and taxes, the Wash­ing­ton Seller Dis­clo­sure State­ment is a sure thing when it comes to sell­ing res­i­den­tial prop­erty in Wash­ing­ton State. Form 17, as it is also called, looms large and larger.

Get­ting more com­plex over time.

The state leg­is­la­ture keeps adding and chang­ing Form 17. The last major change was in 2003. Sub­se­quent effec­tive dates and changes/additions per­tained to:

• Jan­u­ary, 2005: sex offender in area
• June, 2005: prox­im­ity to farms
• June, 2006: farm prox­im­ity lan­guage changed
• June, 2007: envi­ron­men­tal sec­tion added plus other major changes

Major changes include:

• Def­i­n­i­tion and des­tinc­tion between improved and unim­proved res­i­den­tial property
• Amends the exist­ing Form 17 used for “improved” property
• New Seller Dis­clo­sure State­ment to be pro­vided to buyer of “unim­proved” prop­erty zoned for res­i­den­tial use
• Lim­its a Buyer’s abil­ity to waive receipt of either form

Changes to sec­tions of the form include:

• Sec­tion 6 – title of sec­tion changed from “Com­mon Inter­ests” to “Home­own­ers’ Association/Common Interests”.
• Sec­tion 7 – title of sec­tion changed from “Gen­eral” to “Envi­ron­men­tal”. This sec­tion must be pro­vided to the Buyer, and receipt of this sec­tion can­not be waived by the Buyer, if the answer to any ques­tion in the sec­tion is “yes”.
• Sec­tion 7(D) – replaces old ques­tions related to flood­ing with new ques­tion ask­ing about exis­tence of shore­lines, wet­lands, flood­plains, and crit­i­cal areas on the property.

Who must pro­vide Form 17?

The require­ment is get­ting tougher. Not hav­ing occu­pied the premises is likely no longer a valid excuse. One excep­tion remains: when the owner has passed away.

What if the Seller does not pro­vide Form 17?

The buyer can walk away from the pur­chase just before clos­ing and get the earnest money back.

What’s the role of the real estate agent?

The agent can not assist the seller in fill­ing out the form. The buyer acknowl­edges this by sign­ing below a state­ment that reads: “…the dis­clo­sures made herein are those of the seller only, and not of any real estate licensee or other third party.”

Must agents dis­close what they learn from Form 17?

Once the Form 17 has been pro­vided to the buyer the answers become known to the real estate licensees rep­re­sent­ing the seller and the buyer. Hav­ing learned of mate­r­ial facts through Form 17, the real estate licensees must dis­close them.

I am not using an agent to sell my home. Do I need to pro­vide Form 17?

Absolutely.

If you are inter­ested in the details of the new con­tent and ratio­nale behind the changes to the Wash­ing­ton State Seller Dis­clo­sure State­ment, visit the Wash­ing­ton State leg­is­la­ture web­site (pdf file).