Fascinating discussion in BusinessWeek from renowned Peruvian economist Hernando de Soto.

As we have discussed previously (here and here), de Soto has identified the property record keeping — he calls them “public memory systems” — as one of the major advantages of Western Capitalism. The recording, rule-bound, certified, and publicly accessible registries, titles, balance sheets, and statements of accounts, especially for land and houses — is how our system creates “economic facts.”

Various elements in our economy — Shadow banking systems, MERS, abdication of lending standards (i.e., no doc loans and origination fraud), Robosigners, mark-to-model accounting fraud, off balance sheet bank assets — have conspired to destroy those facts. These economic fact destroying gambits turned out to be prime underlying elements of the financial crisis.

Here is de Soto:

“During the second half of the 19th century, the world’s biggest economies endured a series of brutal recessions. At the time, most forms of reliable economic knowledge were organized within feudal, patrimonial, and tribal relationships. If you wanted to know who owned land or owed a debt, it was a fact recorded locally—and most likely shielded from outsiders. At the same time, the world was expanding. Travel between cities and countries became more common and global trade increased. The result was a huge rift between the old, fragmented social order and the needs of a rising, globalizing market economy.

To prevent the breakdown of industrial and commercial progress, hundreds of creative reformers concluded that the world needed a shared set of facts. Knowledge had to be gathered, organized, standardized, recorded, continually updated, and easily accessible—so that all players in the world’s widening markets could, in the words of France’s free-banking champion Charles Coquelin, “pick up the thousands of filaments that businesses are creating between themselves.”

The result 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. The final product was a revolutionary form of knowledge: “economic facts.”

Over the past 20 years, Americans and Europeans have quietly gone about destroying these facts. The very systems that could have provided markets and governments with the means to understand the global financial crisis—and to prevent another one—are being eroded. Governments have allowed shadow markets to develop and reach a size beyond comprehension. Mortgages have been granted and recorded with such inattention that homeowners and banks often don’t know and can’t prove who owns their homes. In a few short decades the West undercut 150 years of legal reforms that made the global economy possible.

The results are hardly surprising. In the U.S., trust has broken down between banks and subprime mortgage holders; between foreclosing agents and courts; between banks and their investors—even between banks and other banks. Overall, credit (from the Latin for “trust”) continues to flow steadily, but closer examination shows that nongovernment credit has contracted. Private lending has dropped 21 percent since 2007. Outstanding loans to small businesses dropped more than 6 percent over the past year, while lending to large businesses, measured in commercial loans of more than $1 million, fell nearly 9 percent.”

De Soto articulates where economics facts were “disappeared” by the players involved in six key areas:

1. Mortgage Bundling
2. Default Swaps

3. Exemptions to “mark-to-market” accounting standards.

4. Off-Balance-Sheet Accounting

5. Government Use of Swaps and Repo Markets
6. Rating Agencies

Astonishing. Go read the entire piece here.

>

Previously:
Foreclosure Fraud Reveals Structural & Legal Crisis (October 5th, 2010)

Why Foreclosure Fraud Is So Dangerous to Property Rights (October 12th, 2010)

Source:
The Destruction of Economic Facts
Hernando de Soto  
BusinessWeek April 28, 2011
http://www.businessweek.com/magazine/content/11_19/b4227060634112.htm

Category: Bailouts, Credit, Foreclosures, Legal, Real Estate, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

33 Responses to “The Destruction of Economic Facts”

  1. ilsm says:

    Sounds like how the pentagon justifies spending to keep the world’s 11 super carriers ready.

    Seems you can fool a lot of the people for a larger some of the time.

  2. george matkov says:

    Great post as usual Barry. Unfortunately, rehashing what went wrong won’t fix things. I don’t see anyone in a position of power doing anything to fix what is broken.

    In our current situation the runup in equities is enough to satisfy the ultrawealthy and powerful. They have been made whole. The rest of us are underwater with no hope of our circumstances improving and no political power to effect any changes.

  3. It is unfortunate that Mr. de Soto or someone of similar stature in academia or journalism does not turn their attention to the U.S. government’s central role in this process – particularly with the statistical fiction relating to U.S. inflation statistics and ideas that anything below 2% inflation is “deflation”….

    The fictional inflation figures and government policy officially ignoring inflation by relabeling it as “non-core” or when all else fails “transitory” is already leading to a severe mistrust of government at all levels….

    Destruction of the pricing mechanism, and destruction of the ability of a currency to serve as a store of value is something that was seen again and again in Latin America, over the past 100 years and has now landed firmly on the shores of the U.S., to the shame of all….

    http://www.shadowstats.com/article/hyperinflation-2010

  4. rktbrkr says:

    Instead of open transparent public records that deSoto says are necessary for a functioning democratic capital system our regulators are taking us backwards with only a few notes documenting Paulson’s huge Sunday night Specials, erasure of mark to market accounting and disobedience of FOIL laws by the FED (and the attempted perversion of Notary laws by the banks and Congress).

    Very little has been done to correct the breakdown in the recording and accounting for mortgages that brought us to the point of crisis a couple years ago and the elimination of mark to market accounting has set us up to be blindsided by an even larger crisis when the banks start selling their MERS clouded foreclosures for scrap value and suddenly recognize huge losses they’ve turned blind eyes to while management enjoys their bonus schemes.

    Counting on the FED to dish out tough love to the TBTF is bass ackwards, they’re running interference for them and counting on Congress to impose regulations on the TBTF is only one off from expecting the FED to do it. As long as the TBTF remain TBTF we’re doomed to recurring crises alternating private gains and enormous public losses.

    From a public perspective the TBTF need to be segmented so that the public banking operations can be continued while other operations can be would down when they are hit by a crisis and reasonable (MTM) accounting must be restored to avoid surprises. From the private FED/TBTF perspective TBTF size & complexity must be maintained to qualify for special “systemic risk” treatment and surprise accounting must be maintained because gradual, orderly recognition of declining asset values would impact management bonuses and wouldn’t present sudden, crises that qualify for sweetheart Sunday night special deals.

    The only way this corrupt circle might be broken is from the ground up, posse comitatus, where the counties and the states bring the big banks to heel and reestablish accurate public land records although it’s probably too late to save the TBTF from the harm they have done to themselves (not to mention the bubble era homebuyers who stepped into their trap.

  5. Jim Bradley says:

    In my view the biggest economic fact is missing. As soon as a central bank can and will selectively bail out certain organizations by front and back-door methods, what is “money” is no longer a solid fact. For example, JPM debt = money, FNMA debt = money, Citi debt = money, AIG insurance = money, while Jim Bradley debt = plain ol’ debt.

    The key is for the elite to get the new inflationary bailout money first. In my view, and at this scale, the one essential invariable element that has to be in place is a compliant central bank.

  6. Perhaps Ron Paul is right?

    ~~~

    BR: I do not know — has he ever addressed any of the issues this post discusses?

    If you were to describe what you were referencing, perhaps including a link or 3, it would be enormously helpful.

  7. RW says:

    Hernando de Soto has been making a name for himself as someone who really does see the big picture: He did not simply rehash the mechanics of the crash nor was he distracted by who to blame, he identified a core structure, a core public good, and the price we paid by damaging it.

    The fact that we cannot even agree on a common set of facts to move forward from the debacle is testament to the weight of the carry. This is our real debt burden and the only ‘deleveraging’ that has any real hope of healing the breach is to reconstitute and strengthen those social memory systems. Everything else will follow if we succeed and no remedy will hold if we do not, it will just slough off like a wet scab on a suppurating wound.

    What took the West centuries of struggle and undergirded both its financial dominance as well as its financial defense was sacrificed for scant profit.

  8. Sunny129 says:

    Amazingly, nothing will change as ‘EXTEND and PRETEND is in full force associated with collective amnesia. we are heading in the direction another financial tsunami to wake up us from this delusional stupor.

    Otherwise one has to believe that more debt on debt spending will lead us to prosperity. We have witnessed that CRIME does pay in a massive scale in FIRE Economy. More moral hazards have been accepted as the solution in the new normal!

  9. Global Eyes says:

    Nothing distorts the economic facts more than 45 years of deficit spending. It destroys the data base upon which all decisions are made and until we unknowingly end up with what we have today: a result with a still uncertain cause.

  10. louis says:

    As LBJ would have said. “make me do something about this” With no pressure from the we the people the banks will not budge. It is time for a massive rework. Put this bullshit behind us and tell the banks they do not control the constitution. Or just stop paying your mortgage, that’s the only bullet you have.

  11. James says:

    In the U.S., trust has broken down between banks and subprime mortgage holders; between foreclosing agents and courts; between banks and their investors—even between banks and other banks.

    And ESPECIALLY between banks and their “customers,” many of whom either face foreclosure or have been foreclosed upon as the result of these practices, and virtually all of whom have been zapped by a horde of fees, many of which are buried in fine print written by stables of lawyers. And to add insult to injury, these same customers have also had to pay a hefty fee to bail these clowns out for their rampant greed that nearly collapsed our financial system.

  12. farmera1 says:

    I’ve had this uneasy feeling for a long time that the US is ungovernable. De Soto has helped me understand another reason why I feel this way. There is just so much water pushing on the dams that hold civilization together and the dam is seriously leaking. No one has the means, or ability to slow/ stop the leaks yet alone rebuild the dam. So it seems we limp along on our way to who knows where, but it won’t be pretty or painless.

    Here are some of the things that I see as major and unsolvable problems:

    -Destruction of economic facts as De Soto says
    -Debt, lots of debt (among a whole range of economic black swans)
    -World wide energy limits/availability
    -Limits to all kinds of things, fertilizers, food, metals
    -A general sense that this country has lost its way, with a dominate immorality or what ever it is
    -Yes I would add the dumping of millions of tons of CO2 into the environment

    Then you think how people must have felt on December 7, 1941 or in 1929 or when ever. I don’t know but I feel like there are lots more issues, problems and looming problems than we have answers for.

  13. cognos says:

    I find this somewhere between “convoluted” and “stupid”.

    The problem was 1% down loans, 5% down, etc. If everyone had 20% down on RE – virtually zero crisis.

    Other arguments – complexity of structured credit or low int rates – fail.

    ~~~

    BR: You are grossly over-simplyfying the issue. If none of the 0% down mortgages were securitized, we would not have had a problem either.

  14. cognos says:

    Recovery looks good. Spx will hit 1400 soon, 1500 by year end. Recovery will likely last for years still.

    All else is pretty silly.

  15. Sechel says:

    Interesting take. And only a foreigner could appreciate what Americans have so taken for granted-RULE OF LAW.
    How quick we are to take for granted rule of law and good accounting. Is it any surprise we’ve don’t know who
    has clear title to properties and too big to fail banks where everyone is so inter-connected and we don’t
    know who ultimately bears CDS risk?

    Do away with MERS, CDS and bring back mark to market.

  16. Cognos – yes, the SPX will hit 14000 – BUT the U.S. dollar will continue to depreciate in the face of extreme monetary looseness —–

    So, you will ultimately be taxed on the realized gains when you will sell your SPX — AND — you will have to use whatever net gains you have to pay for increased costs of food, gas, and everything else you consume.

    Not a fair trade.

    To measure gains on a nominal basis is to ignore reality of the money printing !

  17. Jojo says:

    @george matkov said “…Unfortunately, rehashing what went wrong won’t fix things. I don’t see anyone in a position of power doing anything to fix what is broken.”
    ———
    Nor do I see any concentrated citizen movement to pressure the power brokers/politicians to do anything. All we do is sit on our arses, watch people rant on TV and then post our own rants on the internet about how upset we are and how things could be fixed if only blah, blah, blah…

    We need leaders to help us rise up like they are doing in the Middle East, like we did during the Vietnam protests or like the civil unrest of the mid-1960′s. Change is not going to come from internet rants.

  18. [...] just buy a soda?  What’s wrong with monetary exchange?4. Extending Tim Harford’s idea, are economic facts disappearing (Hernando de Soto)?5. Brazil is massively violating PPP, I can attest to this. 0 comments [...]

  19. Thor says:

    BR – you’ve been on a roll the last couple months with these awesome posts! Thank you!! Keep hitting hard, eventually some of it’s going to stick!

  20. rktbrkr says:

    Runaway inflation is the perfect “fix” for a government with progressive tax rates and a huge deficit, debt and entitlement commitments that have been de-linked from COLA adjustments. Closely linked devaluation of the dollar that stiffs foreign creditors is the icing on the cake. No need for embarrassing tax increases or serious budget cuts. All Uncle Ben has to do is keep on keeping on which is a hell of a lot easier than reversing course. Just blame speculators and the Arabs for inflation.

  21. cognos says:

    BR – while I agree the complexity of securitization have played a role and continue to, it’s very 2nd order. Non- securitized loans can still be sold, even pooled. The 0% down drives bothe the price run-up (bubble) and the magnitude of losses across levered financials. With 20% down neither can be serious.

    If the loans weren’t securitized, there is some more hope the “restructurings” could be done benefiting all parties. That is all. The only big benefit.

    The current process of fighting in courts and foreclosing on $100-500k obligations, only to collect 10c on the $1. It’s a silly tragedy. There was an opt for the govt or big banks or regulations to force a mass restructuring. All failed. It’s ok. It’s over now.

    The only thing the future needs is 20% down.

  22. bdw says:

    There have been efforts to re establish economic facts about who owns mortgage debt but the forces of the crooks in the political process are too great. Check Arizona SB 1259 http://www.mohavedailynews.com/articles/2011/04/28/news/local/doc4db9275470e2a479640481.txt.
    According to the legislative chair of Banking and Finance, the requirement to show chain of title and present ownership of the note (what De Soto and likely Engels would call and economic fact) was “false hope” for the borrower.

    Here is California we have AB 1321, which only ask for mortgage assignments to be recorded. Hopefully, it will at least be heard. (full disclosure: I have worked on this bill) With non-judicial foreclosure there is very little to stop the steamroll that exists without proof and runs on gas of fraud.

  23. Andy T says:

    “BR: You are grossly over-simplyfying the issue. If none of the 0% down mortgages were securitized, we would not have had a problem either.”

    Wha?!

    Pretty bold statement.

  24. louis says:

    “The only thing the future needs is 20% down.”

    Cognos, what if an owner could do this on current property that was reduced to a negotiated value between ower and investor. We did NASA and ARPANET can’t we get two sides together and hammer out a deal so people quit walking?

  25. constantnormal says:

    Dr de Soto is a genuine economist, someone who works hard to make sure that his theories fit the historical record, not one of our more typical clueless theoreticians to whom data that does not fit their theories needs to be minimized or ignored. His book, “The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else” ought to be required reading in every high school in America. Our politicians ought to be sworn into office using a copy of his book rather than a Bible.

    And anyone here who has not had the pleasure of reading his book really ought to make doing so a high priority, lest they continue on with muddied and turgid thinking about property, and what it means to have defensible documentation of ownership.

  26. Winston Munn says:

    It would follow that information is now more valuable, and those who do hold valid information have a significant advantange.

  27. Bill Wilson says:

    Great Article.

    Why are so many people disillusioned with our political economic system? It’s because liberals and conservatives should agree that the rule of law trumps ideology, patronage, and short term political convenience. In reality, liberals and conservatives only seem to agree that rules were meant to be broken.

    People are disillusioned, because there is no trust in the system. Why should I be responsible, and work for a living, when fat cats at Goldman Sachs and deadbeats abusing the social safety net don’t have to.

    Get a group of kids together on the schoolyard and tell them to play a game. They will quickly make rules. Will they argue with each other, but eventually make those rules out of a sense of fairness? I think so. Will they also enforce those rules ruthlessly, despite the protests of those on the losing side. Absolutely.

    Capitalism is after all a game. The rules of the game need to apply to everyone. What happens if the game is a sham? Everyone takes their ball and goes home.

  28. socaljoe says:

    One could also think of this development as another aspect the centralization of power, which has been ongoing since at least the civil war, from local government to the federal level.

  29. MikeW says:

    The United States of Moral Hazard

  30. Winston Munn says:

    Or as the new Goldman Sachs motto exclaims, “We put the FU into fiduciary.”

  31. Francois says:

    There is also the destruction of culture to think about. And, like economic facts, cultural items are societal facts. Lose them and your society ain’t worth bovine fazoo.

    Barry, you are going to love that one: *evil grin*

    http://www.abajournal.com/magazine/article/a_trove_of_historic_jazz_recordings_has_found_a_home_in_harlem_but_you_cant/

    “A Trove of Historic Jazz Recordings has Found a Home in Harlem, But You Can’t Hear Them”

    I think readers can easily guess why.

    The collection is, in a word, historic. “It is a wonderful addition to our knowledge of a great period in jazz,” says Dan Morgenstern, director of the Institute of Jazz Studies at Rutgers University in Newark, N.J. And, Morgenstern says, “the sound quality of many of these works is amazing. Some of it is of pristine quality. It is a cultural treasure and should be made widely available.”

    The question, however, is whether that will happen anytime soon. And if it doesn’t, music fans might be justified in putting the blame on copyright law. “The potential copyright liability that could attach to redistribution of these recordings is so large—and, more importantly, so uncertain—that there may never be a public distribution of the recordings,” wrote David G. Post, a law professor at Temple University in Philadelphia, on the Volokh Conspiracy blog. “Tracking down all the parties who may have a copyright interest in these performances, and therefore an entitlement to royalty payments (or to enjoining their distribution), is a monumental—and quite possibly an impossible—task.”

    Just…FMP!!

  32. [...] The destruction of economic facts.  (Big Picture) [...]

  33. Please find below more information on Ron Paul’s positions….

    He is libertarian, and his focus has been on transparency in government, particularly an unaccountable Fed; most of his published views are in this area rather than in private sector activities (some justifiable criticism is in order here, however, it is certainly a good thing to have someone within government arguing for transparency in government, particularly as government has grown !)

    He is against foreign wars & neoconservatism, supports a firm currency and fiscal position and is against corporate welfare – his could be a compelling candidate in these areas but would certainly have to show some of the same fervor for transparency and good practices in the private sector as he has in the public sector….

    Enron: Under-regulated or Over-subsidized?
    http://www.lewrockwell.com/orig/paul12.html

    No Corporate Welfare:
    http://www.lewrockwell.com/paul/paul32.html

    Federal Reserve Transparency:
    http://paul.house.gov/index.php?option=com_content&task=view&id=1747&Itemid=60

    On Advisors to the New Obama Administration:
    http://paul.house.gov/index.php?option=com_content&task=view&id=87&Itemid=60

    The Republican congress wastes billions of dollars overseas:
    http://paul.house.gov/index.php?option=com_content&task=view&id=198&Itemid=60

    Free Market as Regulator:
    http://www.lewrockwell.com/paul/paul568.html

    What is the price of gold telling us? (fiat money, anti-war, anti-neocon)
    http://paul.house.gov/index.php?option=com_content&task=view&id=178&Itemid=60

    Healthcare and Economic Reform:
    http://www.lewrockwell.com/paul/paul658.html

    Price Controls:
    http://paul.house.gov/index.php?option=com_content&task=view&id=96&Itemid=60

    His Book:
    http://www.amazon.com/gp/product/0446537519?ie=UTF8&tag=rpcom-20&linkCode=as2&camp=1789&creative=9325&creativeASIN=0446537519