Hernando De Soto’s view on this crisis

There is tons of research, speeches on why this crisis happened. However, there is always space for more 🙂 I came across this interesting interview of Hernando De Soto. De Soto has revolutionised the thinking that property rights leads to economic development.

Why does ownership matter so much?
Ownership means that I have something to lose. If you’re a banker, it means that you’ve got collateral. It also means that I’m credible, so you can give me credit. When you think about it, whether it’s ownership, whether it’s credit, whether it’s capital, whether it’s identification, none of the things that make a modern economy are possible without property.

How does this relate to the financial crisis?
The enormous amount of derivatives that had poured into the market—there are close to $600 trillion of these papers around—are also not recorded in a global or centralized manner, or in a manner that allows you to begin to quantify them. [Former SEC Chairman Christopher] Cox thought that maybe the toxic part of all of these assets was $1 trillion to $2 trillion. [Treasury Secretary Timothy] Geithner told us there’s maybe $3 trillion or $4 trillion. Nobody really knows, so in a way [they’ve created an] informal or shadow economy. This unidentified paper is the source of uncertainty and the credit contraction.

So they’re unidentified in the same way that ownership of, say, a slum in Peru or Africa is unidentified.
That’s right. We have worked in places like Tanzania and Egypt and Ethiopia. When you go visit a home there you don’t find justification for it through the books. In other words, it’s not centrally available information. When you talk about shadow economies in many places, it’s not only the economy of gangsters. It’s also economies that are legal in every respect except for the fact that the paper, which backs up the ownership or the evidence that something exists, is not easily and publicly available. That creates the shadow.

So at this point, a Wall Street banker in a $10,000 suit is encountering basically the same problem that Nairobi slum dwellers have had to deal with for decades or more.
Absolutely. The difference, however, is that in Nairobi they are still struggling to understand that a property system is the best way that they can do things. In the United States, every piece of land, every house, every automobile, every airplane, every manuscript for a film, every patent is written up and recorded and described. There’s only one thing in the United States which is not recorded in such a way and that’s derivatives. We’re only talking about 7 percent of the subprime market being in default, yet it is causing a major contraction in your economy. You’re not getting your credit flowing because you don’t know what is where and who it belongs to.

This is pretty much what others have said as well in different ways. Some have reasoned it as financial innovation , some as incentives etc. Soto gives it another interpretation- lack of property rights on derivatives. His solution:

What’s the answer? How do we assign “property rights” to derivatives?
The banks and the holders of all of these instruments have got to report them in such a way that your government and the public knows who owns what and where. Once the light shines, you will know who’s solvent, who’s insolvent. You’ll be able to have a clean debate as to who to help and who not to help. And you’re going to have a much better idea of the consequences of not helping or helping. Right now you’re talking about all of those issues, but you still don’t have the facts. So the first thing is to have the law require those people who own these things to fess up.

This again is too basic and the immediate question is – Why did this take so long? The talks about manifold growth in derivatives markets being dangerous as they are unregulated have been there since a long time.

It sounds so simple when you put it like that, but I guess there are special interests blocking that from happening.
I am convinced that there are special interests. Creating property rights in the United States [was much easier to do], because a lot of the land, the assets, the woods and the rural areas actually belonged to nobody, or they belonged to indigenous people or Mexicans. But in Britain, those who owned property were able to resist registration throughout part of the 19th century. They even argued that public knowledge of who owned what could eventually lead to kidnappers or things of that kind. And they managed to avoid the light being shined [up until 1925]. The fact is that a market economy works on information. If you don’t have the facts, you don’t have a market and you can’t have justice.

Hmm. So,  Soto says it could be some special interests. This is actually opposite of what Stephen Haber and Rajan/Zingales have said – financial systems have not developed because of special interest theory. And here Soto says that special interests could be keeping derivatives from being regulated.

Why? incentives for use. And why do the authorities continue to ignore the developments? Liz Warren had pointed finance indutry is the biggest contributor in in elections. However, all this is too speculative. It will be great to read some research that puts the reasons for this crisis from a political economy perspective.

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